By Laura Geiger and John Vishneski
A company’s insurance program is an asset that is often ignored during corporate transactions. This is a mistake. Understanding the insurance assets available and how to maximize insurance assets during a corporate transaction will give companies an advantage at the negotiating table. Failing to maximize coverage during a corporate transaction can have disastrous results. The attorneys in Reed Smith’s Insurance Recovery Group can counsel companies engaging in corporate transactions on these complicated issues. Good insurance counsel make the transaction process easier and ensure that insurance asset value is maximized.
Step 1 – Understand the value of the insurance at this moment in time. Your company pays a premium for its insurance. Why? Because the insurance you purchase provides value to your company. When purchasing insurance, your counsel, risk manager and broker analyze the historical, current and potential liabilities and both the scope of the current insurance policies in place and the historical coverage in an effort to maximize the value of your company’s insurance. When you engage in a corporate transaction, the same analysis should be made regarding the other company’s liabilities and insurance. Get those policies out of the file cabinet and have your insurance counsel look at them. And remember that even “old” insurance, including general liability (GL) policies from decades earlier, may have current value if it covers long-tail liabilities such as asbestos and environmental liabilities. For this reason it is important to search for historical coverage (especially GL) going back as far as possible for all parties engaged in the corporate transaction. This should be done during due diligence while long-time employees are still around to help, since many such employees are often let go in a corporate combination.
Step 2 – Maximize the value of the insurance into the future. In an ideal world, insurance for specific liabilities would automatically flow with those liabilities. We do not live in an ideal world, and liabilities can be separated for a variety of reasons from the insurance originally purchased to cover those liabilities. When engaging in a transaction, care should be taken to ensure that coverage is maintained. During due diligence, an attorney understanding the applicable law should analyze the insurance policy language regarding corporate succession. Then the companies involved in the transaction should take the necessary steps to ensure that the corporate transaction documents comply with the law and the policies in order to properly maximize coverage.
Step 3 – Consider coverage for certain aspects of the corporate transaction. It is possible to procure transaction insurance that will help facilitate a transaction. For example, representations and warranties insurance (RWI) can provide coverage for indemnification obligations arising out of a breach of the representations and warranties in the transaction documents. RWI, new environmental insurance and historical insurance can all help in striking the balance of how much escrow may be needed for carry-over liabilities and how long the escrow will be available. For example, a seller may insist on a two-year window for claims covered by purchase money set aside as an escrow. RWI, historical insurance and environmental policies can all extend the window of protection and replace or supplement assets otherwise tied up in an escrow. Other types of transaction insurance can reduce specific risks associated with the corporate transaction. Ask your counsel, risk manager and broker, if there are options that would benefit your company.
Step 4 – Make sure your directors and officers are properly covered during the transaction. Often corporate transaction documents contain requirements regarding insurance coverage for directors and officers (D&O insurance) during and following the transaction. The language of such provisions can vary dramatically, and the impact on your directors and officers can be great. If you want excellent leadership, you must protect your directors and officers. Again, consult, your counsel, risk manager and broker to make sure the insurance provides ample protection.
To understand how these issues fit together, let’s look at two fact scenarios.
First, assume for a moment that you sit on the board of directors of Company A. Company A then merges with Company B to form Company C, where you continue to act as a director. The following day you learn that a product produced by Company B has a deadly design flaw and the product has already caused extensive property damage and bodily injury, including the deaths of multiple persons. The effect of this product liability on Company C will differ dramatically based the insurance due diligence conducted prior to acquisition. If, prior to the acquisition, your due diligence team included a lawyer that analyzed Company B’s insurance, provided you with an analysis of the value of the policies, and helped craft terms in the transaction documents to make sure the historical insurance will be available to Company C post-acquisition, you will be in a much better position than if you have no idea whatsoever about Company B’s insurance. Similarly, your response to the news of this product liability will be different if Company B made representations and warranties about the condition of its products and RWI was purchased prior to the transaction. If, however, the insurance aspects of the transaction were given only cursory review, as a director of Company A and then Company C, you may be greatly concerned about whether adequate D&O insurance was procured or whether you will face any personal liability if stockholders come forward to complain about errors and omissions in the transaction process.
Second, assume you sit on the board of Company A, but this time, following the merger all proceeds smoothly until two years after the transaction when an environmental problem is discovered at a property formerly owned by Company B. The terms of the RWI purchased for the transaction the escrow period have ended. Your reaction as a board member of Company C in this situation will depend on the due diligence you did before the transaction. If Company A and Company B were both mined for historical policy information—while their respective long-term employees were present and able to piece together the histories—you are in a much better position to recover the insurance proceeds from any historical insurance. Alternatively, if you entered into the transaction knowing that Company B had already sold back all its historical insurance to capitalize on those assets, then you knew the risk at the time of the transaction and were able to price that into the transaction. However, if you never looked for that information before the transaction, trying to put that information together now, without the benefit of Company B’s employees’ knowledge, will require more effort, may be less effective and may result in a large financial loss to Company B.
To ensure that your company maximizes the available insurance assets it is important to have insurance counsel, like Laura and John, as a part of your deal team. During negotiations, you do not want to leave cash on the table, and that means you cannot leave the insurance assets in the file cabinet.