After nearly a decade of worldwide merger mania, a body of literature is
emerging that details the challenges of merging operations, IT systems, personnel,
and corporate culture. Also emerging: a set of best practices to meet the transition
challenges proactively. These include the following.
- Appointing a transition team composed of people from both companies
representing a range of core functions such as human resources, accounting,
finance, administration, operations, and IT
- An ongoing commitment to communicating openly and often with staffs
of both companies
- In-depth planning with regard to the merging of corporate record-keeping
and IT functions
- Due diligence prior to merger with regard to the finances, liabilities
and risk portfolio of the prospective partner, acquisition, or acquirer
One low-profile but often crucial factor affecting both the advisability
of a contemplated merger or acquisition and its success is the state of the
prospective partner's insurance portfolio. Any corporation moving toward merger
with or purchase of a corporation in the United States must recognize the litigious
climate in which business is transacted—and defend itself, in advance, by making
sure that both its own and its prospective partner's insurance coverage is adequate.
It is not enough to simply assess known liabilities facing a prospective
partner. Under current U.S. law, environmental liabilities and product liabilities
that may be unknown to the seller or potential partner may emerge years and
even decades after the damage occurs—or after a sale or merger becomes fact.
At the same time, insurance assets are generally transferable from a purchased
company to its purchaser. Moreover, old liability insurance policies in most
cases do not expire if damage is later found to have taken place within the
policy period.
It is therefore a key element of pre-merger due diligence to examine not
only a prospective partner's current insurance coverage, but also its long-term
insurance history including the past insurance of major acquisitions. In the
transaction's execution phase, it is essential to ensure that the long-term
insurance records of both parties are effectively recovered, preserved, integrated,
and organized.
A comprehensive historical insurance audit in two stages is thus advisable,
with as much of the prospective partner's insurance history as possible being
obtained prior to the transaction, and a more comprehensive reconstruction and
organization taking place once the transaction has closed. This historical reconstruction
requires its own set of best practices, evolved over the past 20 years in the
discipline of insurance archaeology.
The Legal Landscape: Securing Retroactive Protection for Retroactive Liability
The need for a comprehensive audit of past insurance is the product of 2
decades' worth of rapid escalation of the litigation threats facing all businesses,
indeed all institutions. During that period, the concept of retroactive liability
in particular has multiplied the legal risks of doing business. Under the provisions
of the federal government's Comprehensive Environmental Response, Compensation,
and Liability Act of 1980 (CERCLA, commonly known as "Superfund"), a broad range
of parties can be held jointly and severally liable for extraordinarily expensive
environmental cleanup, often for pollution that occurred decades ago. Under
the laws of successor liability, moreover, even a corporation that purchases
assets may be liable for the seller's liabilities in four situations:
- If it assumes liability for a defective product, expressly or by implication
- If the transaction is deemed by the court to be a consolidation or merger
- If the purchasing entity is deemed a "continuation of the seller"
- If the transaction is deemed fraudulent or in bad faith
Transferable Insurance for Transferable Liabilities
Fortunately for prospective purchasers, there is also some protection against
potential and unforeseen liabilities—in the transferability of insurance assets
from sellers to purchasers. U.S. courts have generally held that a corporation
deemed liable for a predecessor's products or pollution is entitled to coverage
under the predecessor's applicable insurance policies. While it is advisable
that the acquired corporation expressly assign its insurance coverage to the
purchaser, insurance coverage can be assigned without the insurance company's
consent after a loss has occurred. Even when the insurance policy contains a
"no assignment" clause, courts have granted successor corporations coverage
under policies sold to the acquired corporation.
Given the broad transferability of insurance policies to corporate successors,
coupled with the high value of old insurance policies, a comprehensive audit
of a potential acquisition's long-term insurance history can spell the difference
between acquiring a dynamic asset and acquiring a perpetual asset drain. Assessing
a target company's insurance coverage, therefore, is an essential part of due
diligence for any prospective purchase or merger.
Preventing Institutional Memory Loss
Current business conditions have greatly multiplied both the urgency and
the difficulty of reconstructing a historic insurance portfolio. Under the best
of conditions, old records for companies large or small tend to evaporate. They
can be erased by relocation, retirement, or movement of employees; prior ownership
changes; scheduled document destruction; and far more pervasive accidental destruction
or misplacement. Add to this natural entropy and a host of new factors accelerating
institutional memory loss, including the following.
- The high mobility of employees
- The large-scale migration of businesses from old industrial centers
to the Sun Belt
- The conversion of legacy computer systems to Internet-based systems
- The rapid pace of merger and acquisition (Chances are your next transaction
will be the latest in a long series by both parties.)
Under these conditions, a systematic search, or "insurance archaeology dig,"
is often required to ensure that a company's full range of current and past
insurance policies remains accessible.
Mergers and acquisitions represent perhaps the single greatest challenge
to a company's maintenance of institutional continuity, including maintenance
of the historic insurance portfolio. The main obstacle to record preservation
imposed by mergers and acquisitions are their effect on personnel. Not only
do mergers generally trigger at least moderate waves of personnel loss, either
through downsizing or defections, they also, at least temporarily, affect productivity
by forcing large numbers of employees to adopt new procedures, move down the
hall or cross country, and learn to use new software and other equipment.
Mergers create high levels of anxiety and often have a negative effect on
morale, at least temporarily. At the same time, there are the logistical and
physical challenges of merging files and electronic records. The latter generally
requires at least one party to revamp its IT infrastructure—not to mention its
color-coding or file cabinet shape. Oddly, it is often the most mundane physical
details that enable employees to lay their hands on long-filed documents. Mergers
and acquisitions are not kind to the Zen of corporate file maintenance.
Before and After Closing
The difficulty of working conditions in the execution phase of a merger underscores
the need to prepare the ground with as complete a coverage audit as possible
in the negotiation phase. As with all facets of post-merger integration, solid
advance planning followed by prompt and vigorous execution once the deal has
closed will ease rather than aggravate transition trauma. Difficult as working
conditions may be in the immediate post-merger period, it is imperative to move
fast, before old records are destroyed and large numbers of people disappear
through downsizing or defection. If the insurance audit is postponed—or omitted
until a liability crisis leads to a desperate search for missing insurance assets—recovery
may prove impossible.
Conducting at least a preliminary insurance audit prior to purchase is important
not only because it provides the purchaser with data potentially crucial to
assessing the seller's true value, but because the conditions for such an audit
are much more favorable before the purchase than after. As noted above, merger
or acquisition inevitably creates some disruption, and often considerable resentment,
particularly when major personnel changes result. Recently fired employees—or
employees with new bosses, new expectations, and new anxieties—are not likely
to put their "all" into uncovering and documenting old insurance assets. A comprehensive
effort will uncover more assets, preserve evidence, and ensure greater protection
for unanticipated liabilities for decades to come.
At the same time, the negotiation phase of the merger and acquisition process
has a momentum of its own, and circumstances often do not allow adequate time
to reconstruct the past coverage in detail prior to closing. Yet the buyer can
still prepare the ground for complete audit following the purchase and thus
prevent a worst-case scenario in the years ahead. A partial audit can provide
an outline of existing coverage and "freeze" the evidence, ensuring that critical
documentation will not be misplaced, lost, or destroyed, and setting the stage
for a more complete post-merger project.
At a minimum, then, a prospective purchaser ought to establish a corporate
history to identify all predecessor companies of the target company with existing
or potential liabilities. The audit should include pre-acquisition coverage
for operations with significant liability exposures. Then, as soon as possible,
copies of all existing liability policies should be obtained and gaps in coverage
history identified while negotiations are in progress. After assembling all
available documentation of the coverage history of the target company, buyers
need to understand whether the historic policies actually provide coverage.
The presence of customized endorsements, high deductibles, expensive claims
handling agreements, aggregate limits that are nearly or already exhausted,
and insolvent insurers may, in fact, spell inadequate protection for future
losses. Consider the need for specific contract assignment or transfer of insurance
policies in negotiating the purchase and sales agreement. While courts have
upheld the transferability of insurance coverage without such explicit assignment,
insurance companies often attempt to deny coverage on the grounds that such
assignment is missing. Obtaining the assignment can thus forestall costly legal
battles.
In order to complete the audit after the acquisition, develop a checklist
of company insurance records and relevant non-insurance documents. Investigate
records in storage, and arrange to have records retained. Finally, interview
insurance personnel before the transition occurs to determine what they recall
about past coverage and records retention. In the negotiation phase, a prospective
buyer's demand for an insurance audit of a prospective acquisition need not
seem a distraction or intrusion, if it is made clear that the audit may well
uncover assets that enhance the seller's value. Indeed, the seller may be induced
to perform the audit, since doing so potentially augments its saleable assets.
Selling a company with a complete and well-documented insurance history is like
selling a house with a new roof and solid foundation.
Better Late Than Never: Responding to a Post-Purchase Crisis
Reconstructing, documenting, and charting a company's full insurance history
is a formidable task even under favorable circumstances. Getting started years
after an acquisition, when significant litigation or claims are pending, poses
unique but not insurmountable problems. Corporate records will most likely have
been destroyed, and the search will rely heavily on sources outside of the corporate
records.
In this type of situation, begin a search as soon as possible. This will
ensure that no further records are lost. It will also help to avoid a late notice
problem with past insurers. Even if there are no insurance documents, other
corporate records may provide a wealth of leads to outside sources. For example,
the purchase closing documents may contain schedules of insurance, references
to third-party claims or civil lawsuits, names of former employees, and information
on the types of contracts that would have required evidence of insurance. Former
employees may also provide crucial recollections of former owner's internal
records as well as domestic and London brokers, additional insureds, and past
lawsuits. In the aftermath of mergers and acquisitions, identifying outside
sources is often the key to a successful policy search.
Preserving the Corporate Memory
Current business theory puts a great premium on speed—fast decision-making,
fast execution, fast changes in direction, fast growth. Employees have adapted
to this dynamic by learning to move fast themselves, whether by frequent job
shifting or a move to free agency. Technology has both driven and adapted to
the growth dynamic, so that record-keeping systems change as fast as personnel,
business strategy, corporate identity, and location.
But business at Internet speed has its costs. While the corporate "brain"
boosts its processing speed, the corporate memory—the foundation not only of
sound decision-making but also of learned defensive strategies—is in danger
of eroding. Insurance archaeology preserves one element of corporate memory
that can provide tens of millions of dollars worth of defense against current
liabilities.