Mergers & acquisitions: successor before success

Mergers & acquisitions: successor before success

The solicitors’ profession moved to the open market a very long time ago now and issues such as how the successor practice rules will apply in various circumstances ought to be fairly well established and understood. If only it were so states Niall Innes of Mills & Reeve, author of this article on how to handle the issues relating to successor practices.

It is inevitable that successor practice liability will always be a hotly contested issue. Given the potential significance of inadvertently becoming a successor practice, prudent firms and their advisers have spent many hours planning ways to avoid that outcome. Inadvertently becoming a successor can have potentially catastrophic consequences in terms of insurance renewal. Given that the indemnity rules are designed to try to find a successor if at all possible, firms’ schemes have had mixed results.

This article is not about the successor practice rules themselves. The key ingredients are well known. There needs to be a cessation of practice, coupled with an immediate transfer of the business by reference to the guidance in the rules. The rules produce many fruitful arguments. For instance, what amounts to a cessation? Just how immediate does a transfer have to be before the new practice triggers the rules? Equally, how does a firm avoid the risk of holding themselves out as a successor, and yet still acquire the clients and contacts of a former firm, which is presumably the very point of the acquisition?

We advise firms on how to avoid successor practice liability before they acquire practices, or parts of them, and interesting factual arguments abound. But beyond those generic issues, there continue to be circumstances where the answers have not already been determined and where real potential difficulties can arise. Since the fall-back of the Assigned Risks Pool has disappeared, the potential significance of these issues is even more acute than ever before.

The ability to purchase run off cover is the safest way for an acquiring firm, or its insurer, to be confident that successor practice liability will be avoided. If the acquired firm purchases run off cover in return for payment of (usually) three times the annual premium, that should attach any claims to that run off policy. The successor practice rules ought no longer be relevant at all. The practical difficulty is that where firms are being acquired, one of the very reasons for the sale is that the business simply can’t afford expenses such as insurance, let alone run off cover. Complications can arise. Let’s assume the firm being purchased is Smith & Co, and the acquiring firm is Jones & Co. Even if Smith & Co agree to buy run off cover, is that safe enough for Jones & Co? What happens if they fail to pay the run off premium? Does that mean that Jones & Co become successor? Potentially, yes. Acting prudently, Jones & Co should obtain proof of payment before agreeing to acquire although if the insurer issued a policy, or an endorsement covering Smith & Co’s claims for 6 years, there may be an issue about whether the insurer has a right to avoid. Since the minimum terms prohibit a premium payment warranty, the insurer ought to be on risk if they produced the endorsement or policy.

If however there is a “forced” run off because Smith & Co simply ceased trading, or fails to pay the premium, then their insurers would ordinarily be fixed with six years of liability. The first thing which Smith & Co’s insurers will do however, is inevitably to try to pass liability to Jones & Co’s (and their insurers) by saying that Jones & Co have become a successor. Therefore anything short of an actual run off policy or endorsement, with proof of payment, leaves Jones & Co at potential risk.

Even then, does an issue arise if the policy limit for the run off policy is £3m but the claim is for, say, £5m? Once the policy limit is exhausted, are Jones & Co or their insurers liable for the remaining £2m? In principle they ought not be; the rules are a creature of insurance and do not effect liability. Jones & Co ought never be liable for the acts of Smith & Co. Therefore, if the claimant gets judgement for £5m against Smith & Co their routes for recovery are the run off policy and then any remaining assets of Smith & Co or its partners. Jones & Co’s own policy ought not to respond, and the successor practice rules do not apply to top up cover so Jones & Co’s top up policies will not respond. The same applies if the claim arises after the 6 year run off period.

Suppose however that Smith & Co was a partnership with cover of £2m but Jones & Co is an LLP with cover of £3m. Could Jones & Co be at risk to provide cover of £1m in excess of the £2m cover for Smith & Co’s liabilities? Could the insurer who pays the claim seek contribution from the non-paying insurer within the £2m limit on the basis they are co-insurers? We think not, because if Smith & Co has exercised its option to take out run-off cover that ought to be conclusive and there should be no question of Jones & Co being the successor practice. If however Smith & Co has not exercised its option, either the liabilities ought to be met under Jones & Co’s policy if Jones & Co is the successor practice or if it is not they are met by Smith & Co’s run-off cover. The rules don’t expressly rule out the possibility of dual cover, but the intention to rule out that possibility seems reasonably clear.

As the market again sees a growth in the merger and acquisition of firms, questions around successor practices will continue to arise. They are difficult to apply in practice and it should always be remembered that, in the absence of a run off policy, the rules actively seek to find a successor.

Therefore, if you are thinking of acquiring a firm, part of a firm, or even bringing in teams, the successor practice rules need to be a real factor in your commercial decision making. It is just as important as due diligence about the client base and the accounts. If you are going to become a successor practice, you will need to carry out due diligence on the prior practice’s claims record. The day after acquisition it will become part of your own claims record! The successor practice rules are just as important if you are selling, whether voluntarily or because you have no choice. Many deals have collapsed because of successor practice concerns.

Allow time to explore the issues and to work out how to avoid or mitigate issues. Speak to your broker at an early stage and if things progress, take specialist advice on the terms of the deal itself.

About the Professional Indemnity Division at Howden

Howden has one of the UK’s most respected Professional Indemnity Insurance (PII) broking teams. We have the knowledge and expertise to look after businesses operating across a range of sectors and territories and believe firmly in the importance of developing strong relationships with our clients and insurers, based on honesty and respect. We are market leaders in many of the UK’s professional services sectors and our client base includes some of the world’s leading professional services firms.

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