Expert Commentary

Insurance Archaeology for Mergers and Acquisitions: Due Diligence Before and After Closing

One often-crucial factor affecting both the advisability and success of a merger is the prospective partner's insurance portfolio. Any corporation moving to merge or purchase a corporation in the United States must recognize the litigious climate and defend itself by making sure that both its own and its prospective partner's insurance coverage is adequate. Learn more in this insightful article.


Insurance Archaeology
January 2001

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.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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