How Can Asset Purchase Agreement Language Increase Insurance Risk?

When conducting insurance due diligence for an asset purchase, details such as the definition of Assumed Contracts, Assumed Liabilities, and Excluded Liabilities can impact the treatment of the pre-closing insurance policies. If the intent is for the Seller to retain all pre-closing operating liabilities, then all pre-closing insurance policies should also be retained by the Seller. This requires a new, fresh-start insurance program for the post-closing Newco.

However, some first draft APAs have the Seller retaining all pre-closing liabilities on one hand, but on the other hand, have the Buyer assuming the pre-closing insurance policies insuring those same liabilities. This structure is proposed because the Buyer perceives the insurance policy as an asset with value. There are potential pitfalls under this structure that may not have been considered. Two of these potential pitfalls are:

  1. Successor liability: Many insurance policies are “occurrence policies”, meaning the policy in force on the date of the occurrence shall respond. By assuming a policy that would respond to a claim for a pre-closing occurrence (e.g., workers’ compensation or general liability claim), it can be argued that the Buyer assumed that pre-closing liability being insured, thus opening the door to successor liability.
  2. Unintended assumption of accrued liabilities: Many large companies with a high frequency of low severity claims purchase insurance policies utilizing a large deductible or, “loss sensitive” structure. As claims come in, the Company must accrue for the expected loss within the deductible for known claims and an amount for claims incurred but not reported (IBNR). By assuming a policy that insures this pre-closing claims activity, the Buyer also assumes the associated accrual liability.

While the purchase of a new insurance program will incur a cost, that cost can be quantified and accounted for in a financial model. Assuming unknown and unquantified liabilities could be significantly more expensive.

unsplash

Subscribe to keep up with the latest news

Don't miss our next blog post!

Sign up to receive emails about our blog posts, newsletters and webinars.