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Your manufacturing company has announced a new transaction. It will either sell a substantial portion of its assets, or have its stock acquired by another company. As in-house counsel for the seller, you become consumed in responding to due diligence requests by the purchaser, producing customer contracts, financial information, litigation reports, regulatory filings, etc. One area that may be overlooked or left to an insurance broker is the effect of the transaction on your company's insurance program. But delegating insurance issues to a broker who may not be sophisticated in corporate mergers and acquisitions (M&A) may leave a hole in your company's insurance coverage and render your company and its management naked (at least risk-wise).
Product liability is an area where there may be a gap in coverage as a result of an M&A transaction. Product liability insurance is one of the few coverages that is written on either an occurrence or claims-made basis, depending on the extent of the insured's risk and financial ability to pay the premium. This article explores some of the insurance issues arising out of M&A transactions.
D&O Coverage
Probably the most important policy for your senior management is Director and Officer (D&O) liability, which covers management ' and sometimes, the corporate entity ' from claims against them arising from the performance of their duties. It is important to note that D&O policies are written on a claims-made basis. A claims-made policy covers only those claims made within the policy period based on acts or omissions that occurred after a specified date ' sometimes referred to as the “Retro Date.” D&O policies usually have a Change in Control Clause, which provides that upon the change in control of more than 50% of the voting stock of the named insured or upon the sale of substantially all (or a specified percentage of the assets of the company), the coverage of the policy terminates and the policy goes into “run-off” for the rest of its term. Run-off means that the policy will not cover claims that arise from acts or omissions that occur after the date of the transaction. The remainder of the policy term is converted into a reporting period for claims based on facts that arose prior to the transaction. If the Change in Control Clause is triggered, your company's directors and officers will not be covered for their acts and omissions after the transaction date. If the transaction is a sale of assets where the seller will remain in existence afterwards, a new policy covering its directors and officers for post-transaction events is necessary.
Tails
If the transaction results in the seller's discontinuing business, consideration should be given to purchasing a “tail” for the D&O and any other claims-made policies your company may have. A tail is not a new policy; rather, it is an endorsement amending a claims-made policy that extends the time in which claims may be reported by one or more years. It can only be purchased from the carrier that issued the policy in effect at the time of the transaction and can be purchased only during the term of the policy or a short period afterwards. The tail does not provide a new limit of liability; it is subject to the remaining limit of liability of the policy that it amends. Furthermore, since the tail endorsement is usually limited to extending the time period for reporting claims, it generally will be identical to the policy it amends. Often, the availability, cost and length of the tail may be specified in the current policy. Other policies simply provide that the availability and terms of the tail are subject to the discretion of the carrier at the time of the change in control.
Practice Tip: When purchasing a D&O policy, consideration should be given to buying one that requires the carrier to offer tail coverage and specifies the cost and length of the tail. Otherwise, you are at the mercy of the carrier regarding the terms of the tail.
Notice of Circumstances
If a tail policy is not offered by the carrier or is prohibitively expensive, limited tail coverage may be obtained during the current policy period by the insured's issuing a “notice of circumstances” that may lead to a claim. Claims-made policies generally do not cover claims first made after the policy terminates. One exception to this rule is that most such policies contain a provision permitting the insured to give the carrier notice of circumstances that may lead to a claim. The notice of circumstances then acts as a placeholder on that policy such that any future claims that arise from the circumstances noticed will be covered by the policy, regardless of whether the claims are brought after the expiration of the policy. Post-expiration coverage is limited to claims arising from the noticed circumstances. Many policies have specific requirements as to the information that must be provided. Accordingly, it is important that the notice of circumstances be as detailed as possible in order to comply with the policy requirements and to encompass as many future claims as possible. The notice should also be as broad as possible to encompass any conceivable claims. The limitation to this approach is that coverage will be limited to those claims that are at least somewhat foreseeable.
General Liability Insurance
Change in control issues are not limited to claims-made policies. General liability policies are almost always written on an occurrence basis, but may also contain a provision terminating coverage upon a change in control of the named insured. If the seller will continue in business after a transaction that triggers a Change in Control Clause, it will need to purchase a new general liability policy post transaction. Tail coverage for future claims arising from injuries sustained prior to the transaction is not necessary for occurrence-based policies because the coverage of occurrence-based policies is not limited to claims arising during a specified reporting period. An occurrence-based general liability policy covers injuries that occur during the policy period, regardless of whether the claim is brought one year, 10 years or even longer after the expiration of the policy period.
Product Liability Insurance
Product liability insurance was historically offered on an occurrence basis and is still written that way for low-risk insureds. However, insureds with a high product liability exposure may be forced to obtain such insurance on a claims-made basis because occurrence coverage is unavailable or the premium would be prohibitively expensive.
Regardless of whether the seller continues to make or distribute products after the transaction, it may be sued in the future based on products made in the past. If the seller's product liability insurance was written on a claims-made basis and the Change in Control Clause is triggered, it will be necessary to purchase a tail endorsement to the last policy in order to have coverage of post-transaction claims arising from pre-transaction products.
If the seller's product liability coverage was written on an occurrence basis, it should continue to purchase product liability insurance after the transaction, even if it no longer manufactures or distributes products. This is necessary in order to cover post-transaction injuries from products manufactured by the seller pre-transaction. If a product was manufactured or distributed by the seller prior to the transaction but the product causes an injury after the transaction, the claim will not be covered by the seller's policy in effect at the time of manufacture or distribution because it is the occurrence of an injury in the policy period that usually triggers coverage under an occurrence policy. The seller must continue to purchase additional product liability coverage after the transaction to insure against future injuries from past products.
The need for insurance against legacy product liability claims may not be limited to the seller. Some states, like California and New Jersey, have adopted the “product line” theory of liability that holds a purchaser of assets liable for the product liabilities of companies whose assets it purchased. The buyer's product liability policy is usually not going to cover it for claims arising from products it did not manufacture or distribute. One solution is for the buyer to require that the seller name it as an additional insured on the seller's post-transaction product liability policies. Practically speaking, however, this provision is hard to enforce in future years and does not protect the buyer if the seller goes out of business. A better solution is for the buyer to purchase “discontinued products coverage.” This coverage insures the buyer against product liabilities from injuries arising from products manufactured or distributed by the seller prior to the transaction.
Another insurance issue resulting from an asset acquisition is continuation of additional insured status for the buyer. To the extent that contracts entered into by the seller will be assigned to the buyer and those contracts name the seller as an additional insured on the counter-party's liability policies, the buyer should make sure that the contracts are amended to provide that the buyer be named as an additional insured on such policies. To effectuate additional insured status, it is essential that there be a written agreement with the named insured requiring it to add the buyer as an additional insured on its policy. This is because the ISO “Blanket Additional Insured Endorsement” in many policies limits additional insured coverage to those entities with whom the named insured has a written agreement requiring it to add the buyer as an additional insured on its policies. Much coverage litigation has arisen where a party thought it was an additional insured on another's policy, only to find out that the absence of the requisite additional insured clause in the underlying agreement is fatal to additional insured coverage.
Conclusion
Careful consideration of the existing insurance programs, your company's risk profile and its future business strategy is essential to avoid unexpected gaps in its insurance coverage.
Your manufacturing company has announced a new transaction. It will either sell a substantial portion of its assets, or have its stock acquired by another company. As in-house counsel for the seller, you become consumed in responding to due diligence requests by the purchaser, producing customer contracts, financial information, litigation reports, regulatory filings, etc. One area that may be overlooked or left to an insurance broker is the effect of the transaction on your company's insurance program. But delegating insurance issues to a broker who may not be sophisticated in corporate mergers and acquisitions (M&A) may leave a hole in your company's insurance coverage and render your company and its management naked (at least risk-wise).
Product liability is an area where there may be a gap in coverage as a result of an M&A transaction. Product liability insurance is one of the few coverages that is written on either an occurrence or claims-made basis, depending on the extent of the insured's risk and financial ability to pay the premium. This article explores some of the insurance issues arising out of M&A transactions.
D&O Coverage
Probably the most important policy for your senior management is Director and Officer (D&O) liability, which covers management ' and sometimes, the corporate entity ' from claims against them arising from the performance of their duties. It is important to note that D&O policies are written on a claims-made basis. A claims-made policy covers only those claims made within the policy period based on acts or omissions that occurred after a specified date ' sometimes referred to as the “Retro Date.” D&O policies usually have a Change in Control Clause, which provides that upon the change in control of more than 50% of the voting stock of the named insured or upon the sale of substantially all (or a specified percentage of the assets of the company), the coverage of the policy terminates and the policy goes into “run-off” for the rest of its term. Run-off means that the policy will not cover claims that arise from acts or omissions that occur after the date of the transaction. The remainder of the policy term is converted into a reporting period for claims based on facts that arose prior to the transaction. If the Change in Control Clause is triggered, your company's directors and officers will not be covered for their acts and omissions after the transaction date. If the transaction is a sale of assets where the seller will remain in existence afterwards, a new policy covering its directors and officers for post-transaction events is necessary.
Tails
If the transaction results in the seller's discontinuing business, consideration should be given to purchasing a “tail” for the D&O and any other claims-made policies your company may have. A tail is not a new policy; rather, it is an endorsement amending a claims-made policy that extends the time in which claims may be reported by one or more years. It can only be purchased from the carrier that issued the policy in effect at the time of the transaction and can be purchased only during the term of the policy or a short period afterwards. The tail does not provide a new limit of liability; it is subject to the remaining limit of liability of the policy that it amends. Furthermore, since the tail endorsement is usually limited to extending the time period for reporting claims, it generally will be identical to the policy it amends. Often, the availability, cost and length of the tail may be specified in the current policy. Other policies simply provide that the availability and terms of the tail are subject to the discretion of the carrier at the time of the change in control.
Practice Tip: When purchasing a D&O policy, consideration should be given to buying one that requires the carrier to offer tail coverage and specifies the cost and length of the tail. Otherwise, you are at the mercy of the carrier regarding the terms of the tail.
Notice of Circumstances
If a tail policy is not offered by the carrier or is prohibitively expensive, limited tail coverage may be obtained during the current policy period by the insured's issuing a “notice of circumstances” that may lead to a claim. Claims-made policies generally do not cover claims first made after the policy terminates. One exception to this rule is that most such policies contain a provision permitting the insured to give the carrier notice of circumstances that may lead to a claim. The notice of circumstances then acts as a placeholder on that policy such that any future claims that arise from the circumstances noticed will be covered by the policy, regardless of whether the claims are brought after the expiration of the policy. Post-expiration coverage is limited to claims arising from the noticed circumstances. Many policies have specific requirements as to the information that must be provided. Accordingly, it is important that the notice of circumstances be as detailed as possible in order to comply with the policy requirements and to encompass as many future claims as possible. The notice should also be as broad as possible to encompass any conceivable claims. The limitation to this approach is that coverage will be limited to those claims that are at least somewhat foreseeable.
General Liability Insurance
Change in control issues are not limited to claims-made policies. General liability policies are almost always written on an occurrence basis, but may also contain a provision terminating coverage upon a change in control of the named insured. If the seller will continue in business after a transaction that triggers a Change in Control Clause, it will need to purchase a new general liability policy post transaction. Tail coverage for future claims arising from injuries sustained prior to the transaction is not necessary for occurrence-based policies because the coverage of occurrence-based policies is not limited to claims arising during a specified reporting period. An occurrence-based general liability policy covers injuries that occur during the policy period, regardless of whether the claim is brought one year, 10 years or even longer after the expiration of the policy period.
Product Liability Insurance
Product liability insurance was historically offered on an occurrence basis and is still written that way for low-risk insureds. However, insureds with a high product liability exposure may be forced to obtain such insurance on a claims-made basis because occurrence coverage is unavailable or the premium would be prohibitively expensive.
Regardless of whether the seller continues to make or distribute products after the transaction, it may be sued in the future based on products made in the past. If the seller's product liability insurance was written on a claims-made basis and the Change in Control Clause is triggered, it will be necessary to purchase a tail endorsement to the last policy in order to have coverage of post-transaction claims arising from pre-transaction products.
If the seller's product liability coverage was written on an occurrence basis, it should continue to purchase product liability insurance after the transaction, even if it no longer manufactures or distributes products. This is necessary in order to cover post-transaction injuries from products manufactured by the seller pre-transaction. If a product was manufactured or distributed by the seller prior to the transaction but the product causes an injury after the transaction, the claim will not be covered by the seller's policy in effect at the time of manufacture or distribution because it is the occurrence of an injury in the policy period that usually triggers coverage under an occurrence policy. The seller must continue to purchase additional product liability coverage after the transaction to insure against future injuries from past products.
The need for insurance against legacy product liability claims may not be limited to the seller. Some states, like California and New Jersey, have adopted the “product line” theory of liability that holds a purchaser of assets liable for the product liabilities of companies whose assets it purchased. The buyer's product liability policy is usually not going to cover it for claims arising from products it did not manufacture or distribute. One solution is for the buyer to require that the seller name it as an additional insured on the seller's post-transaction product liability policies. Practically speaking, however, this provision is hard to enforce in future years and does not protect the buyer if the seller goes out of business. A better solution is for the buyer to purchase “discontinued products coverage.” This coverage insures the buyer against product liabilities from injuries arising from products manufactured or distributed by the seller prior to the transaction.
Another insurance issue resulting from an asset acquisition is continuation of additional insured status for the buyer. To the extent that contracts entered into by the seller will be assigned to the buyer and those contracts name the seller as an additional insured on the counter-party's liability policies, the buyer should make sure that the contracts are amended to provide that the buyer be named as an additional insured on such policies. To effectuate additional insured status, it is essential that there be a written agreement with the named insured requiring it to add the buyer as an additional insured on its policy. This is because the ISO “Blanket Additional Insured Endorsement” in many policies limits additional insured coverage to those entities with whom the named insured has a written agreement requiring it to add the buyer as an additional insured on its policies. Much coverage litigation has arisen where a party thought it was an additional insured on another's policy, only to find out that the absence of the requisite additional insured clause in the underlying agreement is fatal to additional insured coverage.
Conclusion
Careful consideration of the existing insurance programs, your company's risk profile and its future business strategy is essential to avoid unexpected gaps in its insurance coverage.
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