Periodically clients will close or sell their business due to retirement or other reasons. These situations can affect insurance coverage for both the buyer and seller after the sale is complete.
1. I’m retiring and going to sell (or close) my business. Do I need to worry about the potential of future law suits, once the sale is complete?
Yes. Just because you are no longer in business does not mean that your risk of a goes away completely.
2. How can I be sued if I’m no longer in operation?
This depends on the type of business entity and the nature of your operations. However, here are two examples:
First, consider a small electrical contractor that has been in business for many years. The wiring job he did six months before he closed up shop may contain a defect – say an improper connection that works loose over time. Six months after he retires – a year after he finished the job – the bad connection starts a fire in the home. Chances are good that, once the cause is identified, the homeowner will sue you for having caused the damage.
In the second example we have a CPA that did tax returns for many years. A year after he retires, a former client is audited by the IRS and it is discovered that an error by the CPA results in significant penalties being added to the back taxes now due, and the client also needs to hire an expensive tax attorney to defend him. He will likely make a claim against you.
3. I’m no longer in business, how can they sue me?
First, as a general rule, anyone can sue anyone for any reason. Even if completely frivolous, it can still be very expensive to hire an attorney to defend you and get you out of the situation. Second, it also depends on what type of legal entity you were while in business. Sole proprietors and partners leave their personal assets completely exposed even after they sell or close the business. LLCs and corporations can offer some protection for your personal assets, but the corporate assets remain exposed. After a business is sold or closed there may be a period of time where assets remain in the corporation while details are wrapped up. It is during this period that you remain at risk. You should review your situation with an attorney to determine the best way to handle things.
4. I’m the electrician in question #2 and am getting sued. Won’t my old insurance policy protect me? I didn’t renew it after I closed up shop since I wasn’t in business.
You likely have a problem. In our example above, the fire did not happen until after you let your policy expire. The standard general liability policy only covers occurrences that take place during the policy period. No policy in force when the fire happened? No coverage. (Note the standard GL policy will cover claims that happened during the policy period even if they are not reported until after expiration.)
5. If my old policy is no good for claims that happen after it expires, what can I do?
There are two approaches for this situation. First, you may consider renewing your policy or buying a specialty “discontinued products or operations” policy that covers at least the time period that assets will remain exposed. You’ll need to have your insurance broker check your available options. Second, if you are selling your company, is to have the buyer add you to their policy as an insured or agree to indemnify you for the period during which you are at risk. If they will agree to this, it should be made part of your written buy/sell agreement.
For LLCs and corporations, once the legal entity is completely defunct and no longer has assets, you should be able to drop the insurance policies. You will want to review this with your attorney and also have him review how the statute of limitations or other laws may apply.
6. I’m the CPA in question #2 and am getting sued. Won’t my old insurance policy protect me?
I didn’t renew it after I closed up shop since I wasn’t in business. You may have a problem if you didn’t take advantage of the opportunity to buy a “tail” (also known as an “extended reporting period”) when you canceled your accountant’s professional liability or let it expire. This is a special provision for most professional liability policies that allows you to receive continued coverage for claims that are later reported involving the work you did prior to quitting your business.
7. I’m not an electrician nor a CPA. I’m selling my business so I can retire. What do I need to do?
There are far too many different types of businesses to give recommendations for each in a short FAQ. It also depends on how the buyer is purchasing your company. In general, the transaction will be one of two types: a stock acquisition or an asset-only purchase.
8. What is the general difference between the two?
A stock purchase is where you sell 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 the buyer has purchased XYZ’s liabilities along with their assets. They’ll be responsible for any claims that are discovered even if they took place prior to their purchase.
An asset purchase means that you have sold 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 you. This arrangement typically means the seller will need to change the name, even if slightly. “XYZ, Inc.” could become “XYZ, LLC” for example.
9. So, as seller, I want this to be a stock sale?
There are advantages for the seller when it comes to liability claims. However, keep in mind that just because the seller wants a stock sale or requests the buyer provide a certain type of insurance or indemnification does not mean that the buyer will agree to it. The results of those business negotiations may increase the buyer’s risk in certain areas and thus they may be reluctant to agree to those provisions. However, it is important that both the buyer and seller work closely with their respective attorneys, accountants and other advisors including insurance brokers. The types of insurance needed for various businesses can vary widely depending on the nature of their operations, products and business activities. Also, let your insurance broker review the indemnification and insurance sections of the buy/sell agreement. Who is required to indemnify who and under what circumstances can vary widely.
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 you and your business, please contact us today.