Buying or selling a business in Australia: run-off cover and the seven-year tail

Selling a business does not necessarily end an Agent’s exposure to claims from earlier work. A look at how Professional Indemnity and Management Liability may need to be reviewed when ownership changes, and why run-off cover and the so-called seven-year tail matter to both sides of the transaction.

A business sale is generally negotiated around the trading metrics – rent roll, sales register, management fees, vendor introductions, key staff retention. The insurance arrangements are usually addressed late in the process, often in the final week before settlement. That is the point at which a few specific questions need to be answered carefully, because Professional Indemnity and Management Liability do not work the way most business policies do.

Both Professional Indemnity and Management Liability are generally written on a claims-made basis. The policy usually considered is the one in force at the time the claim is made or first notified, not simply the one in force when the underlying work was done. That single feature drives almost everything else in the conversation about buying or selling an agency.

The claims-made principle and why it matters at settlement

On a claims-made wording, a complaint received next year about advice given two years ago is the responsibility of next year's policy. If there is no policy in place later, because the selling entity has stopped trading and stopped renewing, there may be no policy available to respond to the claim, regardless of the underlying merits.

That is the gap that run-off cover is designed to close.

What run-off cover does

Run-off cover is arranged to extend the seller’s Professional Indemnity and Management Liability protection for claims made after the business has ceased trading, in respect of work done before that date. It does not cover any new work – there is no new work – but it keeps responding to historical exposures as they emerge.

Run-off is generally placed for a defined period, with seven years often used as a common market benchmark in Australia. It should not be treated as a universal rule. The appropriate period can depend on the state, the type of claim, the transaction structure, the warranties given and any legal advice received. We work with the business and, where required, its legal advisers to settle on a period that fits the specific circumstances.

Who pays for run-off – and why it should be agreed early

The cost of run-off is one of the items most commonly missed in the heads of agreement. It is usually the seller's cost, because run-off protects the seller's historical conduct. In practice, however, it sometimes ends up being negotiated between the parties as part of the overall consideration. Either way, it is materially easier to agree the position before the contract is signed than to revisit it the week before settlement.

“Settlement day is not the day the seller's liability ends. It is the day the seller needs to make sure the policy standing behind their historical work is properly arranged.”

Run-off premiums vary and should be obtained early in the transaction process. The cost can depend on the business’s claims history, scope of services, limit selected, run-off period and insurer appetite.

The buyer's perspective: what happens to the existing policies

From the buyer's side, the question is what happens to the historical work the buyer is now responsible for. If the buyer is purchasing the shares in the business entity, the existing Professional Indemnity and ML policies usually continue, but the change of control will need to be notified to insurers and the wording may need to be reconfirmed. If the buyer is purchasing the business and assets, the existing policies remain with the seller, and the buyer's Professional Indemnity needs a retroactive date that reaches back to cover the historical conduct the buyer has assumed responsibility for, or the seller's run-off needs to be set up to respond to that conduct instead.

Neither approach is automatically right or wrong. They are different ways of arranging protection for historical exposure, and the decision is generally driven by the deal structure, the warranties given by the seller, and the cost. The important point is that the agreed approach is in place from settlement day onwards, not arranged after the event.

Management Liability and the change of control

Management Liability deserves its own treatment in any business transaction. The policy is designed to respond to certain claims against directors and officers, employment practices matters and statutory liability exposures, depending on the wording. The seller's directors usually want continued protection in respect of their conduct prior to settlement – including any allegations that surface in the months and years afterwards. Management Liability run-off is the corresponding cover, and it is often considered for the same period as the Professional Indemnity run-off.

The buyer's incoming directors will then need their own ML policy from settlement day onwards.

What we look at when we are involved in an agency sale or purchase

When an agency engages us in advance of a sale or purchase, the work focuses on a small number of specific items. Confirming the structure of the transaction and what it means for the existing Professional Indemnity and ML policies. Obtaining run-off quotations early enough that the cost can be reflected in negotiations. Reviewing the retroactive dates on the buyer's own program. Confirming what cover the seller's directors will have, and for how long. And confirming that the certificate of currency provided to the other side reflects the position that has been agreed.

A business sale may be the largest single financial event in an Agent’s career. The insurance work that surrounds it is comparatively small, but it is one of the items that can leave the seller exposed years after settlement has completed. Handled properly, run-off cover can reduce that exposure.

If you are considering buying or selling an agency, or you have done so recently and would like to confirm the run-off position, we are happy to walk through it with you.