When buying a business, it is important to be aware of any potential insurance challenges a business owner may face depending on the type of purchase. In this FAQ, Crane Agency will examine the differences between a Stock Acquisition and an Asset-Only Purchase.
1. I’m going to buy someone else’s business. What insurance issues do I need to worry about?
This can be a complicated situation. Typically, the first question your insurance broker will ask you is what type of purchase – a stock acquisition or an asset-only purchase?
2. What is the general difference between the two?
A stock purchase is where you purchase the entire company as it is currently structured. “XYZ, Inc.” will continue to operate as exactly the same company after your purchase. From an insurance perspective, the most important thing to understand is that you have purchased XYZ’s liabilities along with their assets. You’ll be responsible for any claims that are discovered even if they took place prior to your purchase. An asset purchase means that you have purchased only the physical assets of the company, typically along with their customer list and goodwill. The responsibility for liabilities that were incurred prior to the purchase remain with the seller. This arrangement typically means you will need to change the name, even if slightly. “XYZ, Inc.” could become “XYZ, LLC” for example.
3. What potential insurance issues might I face with a stock purchase?
A stock purchase means you need to review the existing liability policies (general liability, auto liability, workers’ compensation, umbrella, professional and management liability) very carefully. In liability claim situations, it can be months or even years before someone comes forward with their claim or lawsuit. For example, consider a company that sells small household appliances. A fire breaks out in a home and, months later, investigators determine the fire was caused by the faulty toaster purchased from the business that now belongs to you. Since the fire started before you bought the company, the claim would be paid for by the general liability policy that was in force the day the fire happened. That means you will need to report the claim under the insurance policy in force prior to your purchase. If the prior owner had inadequate insurance, or none, that means you are responsible for an uninsured or underinsured claim.
4. What does potential insurance issues might I face with an asset purchase?
An asset purchase means that while you acquire the business assets of the company, the preexisting liabilities of all types – loan and contractual obligations, lawsuit liabilities, etc. – remain with the seller. This applies even if the prior liabilities are unknown at the time of the sale. Generally speaking, this is good news for the buyer. However, this doesn’t automatically make all problems go away. The public at large is often unaware of the change of ownership (particularly if the company name or DBA doesn’t change much). If a lawsuit or claim arises, you stand a good chance of having those papers delivered to you. While the prior owner may still end up ultimately responsible for the claim, you may incur legal expenses to defend yourself and get dropped as a defendant. Even that doesn’t necessarily guarantee that you’re out of the picture, especially if the prior owner had inadequate or no insurance. Plaintiff attorneys can be quite the bulldogs when looking for a deep pocket. From that perspective, it still behooves you to make sure the prior owner had appropriate coverage in place. You may even want them to purchase a specialty “tail” policy that continues to provide coverage for claims that happen after the sale, but which involve products sold or operations performed prior to that.
5. What about other policies such as those for property insurance, contractors’ equipment, crime, auto physical damage and others?
Prior to the purchase, these types of policies are primarily for the seller’s benefit. As “first-party” policies, they provide coverage for the physical loss of the seller’s own property. However, for both stock and asset purchase sales, a buyer still has a general interest in knowing that the property he is buying is fully insured prior to his purchase. What if there is a fire, auto accident or embezzlement discovered just days or weeks before the closing date of the sale? If underinsured (or no insurance at all), this could greatly complicate things, even to the point of canceling the purchase of the business. With proper coverage in place, both the seller and the buyer will know that the property will be repaired or replaced to its condition prior to the loss.
6. Can I simply keep the seller’s current policies in place with no changes?
The answer to that question is “it depends.” Most commercial insurance policies contain a condition that states the policy may not be transferred to another party without the insurance company’s written consent. This means that if the acquisition is a stock purchase and the named insured will remain exactly as before, with only a change in the underlying ownership, you may be able to continue the existing policies as-is. Even then, many insurers will want to re-underwrite the policies once they find out the ownership has changed. If the sale is an asset purchase, this will mean that the named insured will be changing. You will not be able to assume the prior owner’s policies unless the insurance company specifically approves the change and issues a policy endorsement. Often, even if the carrier is willing to continue writing coverage, they will want to cancel the current policies and issue new ones effective the date of the sale. Either way, we recommend that you use this opportunity to completely review the insurance program. Often you will find that the insurance philosophy of the old owner is not the same as yours. The date of the sale is an excellent time to review and update coverages, whether you maintain the existing policies or not.
7. What other issues should be considered?
It is important that both the buyer and seller work closely with their respective attorneys, accountants and other advisors as well as their respective insurance brokers. The types of insurance needed for various businesses can vary widely depending on the nature of their operations, products and business activities. For example, some businesses may have a serious need for pollution insurance, while that may be a relatively remote potential for loss for others. Pollution can be a big issue if you are buying a building or land that may have had hazardous operations in the past. Under the Federal Superfund law, you can find yourself responsible for the clean-up of that pollution and related claims even though you had no part in creating the problem. Also let your insurance broker see at least the indemnification and insurance sections of the buy/sell agreement. Who is required to indemnify who and under what circumstances can vary widely. Also, keep in mind that just because the buyer requests the seller provide a certain type of insurance or indemnification does not mean that the seller will agree to it. The results of those business negotiations may increase the buyer’s risk in certain areas and therefore the need for certain types of insurance.
For the best possible outcome, it is most important to keep all of your advisors informed and working together as a team on your behalf. If you would like more information on how Crane Agency can help protect your business, please contact us today.