Exelon Corp., the largest United States nuclear operator, announced recently that it would agree to purchase Pepco Holdings, Inc. for $6.8 billion in cash. Pepco no longer generates its own power, but serves utility customers from Washington, D.C. to New Jersey. Bloomberg reports that this merger, if approved, would create the largest electric and natural gas utility in the Mid-Atlantic region.
The merger will require approval by both the Federal Energy Regulatory Commission and the public service commissions in the relevant states and the District of Columbia. It will also need to pass antitrust review by either the Department of Justice or the Federal Trade Commission. Lawyers, consultants, and accountants for both companies will undoubtedly conduct extensive diligence reviews.
A focus on insurance to cover potential and ongoing liabilities is key to maximizing protection of companies’ assets during a merger or acquisition.
Large companies with significant geographic footprints frequently possess significant holdings that need to be protected. A top-to-bottom analysis of the insurance coverage held by each party to a transaction, and an analysis of the coverage available and needed for the combined company going forward, will be crucial to risk management in multi-billion dollar deals.
There are myriad insurance coverage issues that can arise during an acquisition. Three key issues involve:
- assignment of insurance;
- provisions in directors and officers policies that insurers may contend limit or terminate coverage in the event of a change in leadership or control of a company; and
- ensuring adequate coverage for historical liabilities.
Many insurance policies contain a clause barring assignment without the insurer’s written consent. While the majority rule is that such anti-assignment clauses are not effective if the loss has already occurred, insurers nevertheless often attempt to raise such clauses in attempts to avoid coverage following a corporate transaction. In addition, several courts hold that when an acquiring or successor corporation acquires liabilities by operation of law, it also acquires the corresponding insurance coverage by operation of law. Nevertheless, assignment of insurance policies can be an important concern in a corporate transaction.
Directors and officers insurance policies may contain “change of control” provisions, which insurers may argue serve to limit or terminate coverage if there is a change of control of the company. These clauses typically take effect if the insured company consolidates with or merges into another entity such that the insured company is not the surviving entity, or sells all or substantially all of its assets to another entity. Alternatively, many policies contain provisions requiring the insured to notify its insurer if it acquires more than a certain percentage ownership in another company. Generally, coverage for the acquired company will terminate upon closing of the transaction, though claims arising from pre-transaction acts may be covered. The surviving company may need to modify its policy to ensure that there is no gap in coverage.
If there is a risk, as is often the case, that the transaction itself may give rise to liabilities for the company’s directors and officers, coverage for both entities should be carefully considered to ensure that the transaction will be covered in the event a claim is made arising out of the transaction.
Many companies also contend with historical, or “long-tail” liabilities, such as asbestos, toxic tort, silica, or environmental liabilities. Such liabilities may impact historical coverage that the company purchased decades earlier and potentially involve insurance to which it has rights by way of prior corporate transactions involving subsidiaries or acquired companies. Historical liability insurance can be crucially important when analyzing a target company’s financial strength, because it may provide significant limits and fewer exclusions than modern coverage. For ongoing liabilities, however, historical policies may have been settled or the limits may have been used to pay claims, and may not be available in the future. Prior to entering into a corporate transaction, it is important to understand the target company’s entire historical insurance portfolio and the full extent of its existing and potential liabilities.