Mike Yeager, Senior Underwriting Specialist, Chubb
Mergers and acquisitions continue to be a source of growth for the biotechnology industry. Even the financial crisis has not significantly slowed this trend. In fact, a weakened global economy may have further fueled consolidation as biotechnology companies sought additional efficiencies in R&D, procurement or administration.
Since many biotechnology companies have complex corporate structures—some with hundreds of subsidiaries—executives at acquiring companies recognize that along with the benefits of the acquisition come the risks of assuming the financial liabilities associated with the selling company and its subsidiaries that took place prior to the transaction.
The successor firm may believe that their own or the selling firm’s commercial general liability insurance policy will protect them in an M&A. What some firms may not know is there could be a gap in the coverage offered by the general liability insurance policy that can leave the successor firm exposed to the financial and reputational burden of a successor liability lawsuit.
Most general liability insurance excludes coverage for events that occur prior to an acquisition. When you buy a company, its future activities often will be covered under your commercial general liability insurance policy, but pre-merger activities are typically excluded. In addition, successor liability issues typically will not be covered under the seller’s insurance policy, because the buyer is not named as an insured party.
Even purchase and sale agreements cannot guarantee protection from successor liability. For instance, if your lawyers structure the deal as an asset-only transaction, you may still be liable for prior events if the selling company is unable to fulfill its obligations. Alternatively, a court could decide that the successor organization is simply a continuation or reincarnation of the prior company, therefore the successor may be held responsible for prior liabilities despite the purchase agreement.
In addition, purchase and sale agreements may overlook successor liability issues. These agreements typically state: “Any product manufactured by the selling entity prior to the date of sale, whether those liabilities are future or past, are retained by the selling entity.” But what if the product was manufactured but still sitting in a warehouse or at a distributor? The timing of events can be nebulous, and if it does not match up with the agreement language, the buying company could wind up with liability that it did not bargain for.
Given these gaps in insurance protection, what should the acquiring company consider to help mitigate M&A successor liability risks?
- Identify the selling firm’s key M&A and risk management executives, both staff and advisors. Contact them immediately to uncover prior losses and existing insurance arrangements.
- Understand the firm’s corporate structure. How was the company organized? What were the dates of formation, acquisition, and divestiture for every current and discontinued division?
- Do your due diligence on past operations. Look for activities that may have caused injury or damage in the past and that may result in future claims. Pay special attention to products with a long history.
- Evaluate pipeline products not just in terms of possible marketplace success, but also from an adverse event perspective. Will patients be surfacing with suits due to injuries sustained in clinical trials?
- Do not forget due diligence on all of the selling company’s outsourced manufacturers and component suppliers. Since there is a lot more outsourcing going on in the biotechnology industry these days, make sure you’re comfortable with all of the third parties involved with manufacturing.
- Consider purchasing a successor liability insurance policy. This type of insurance can help protect the buyer against future claims that arise out of an acquired company’s prior activities.
Clearly, biotechnology companies will continue to look for acquisitions to strengthen their product pipelines, acquire manufacturing capacity, and secure a presence in emerging markets. In order for these deals to succeed, executives must carefully mitigate their underlying successor risks.
Mike Yeager is a senior underwriting specialist at Chubb’s Philadelphia branch office and can be reached at email@example.com. He will be moderating a panel on this topic at the upcoming 2011 BIO International Convention.