The U.S. Court of Appeals for the 3rd Circuit’s recent opinion in PNC Bank, N.A. v. AXIS Ins. Co. has made clear that courts will not apply relaxed interpretations to insurance policy exclusions for prior wrongful acts of newly acquired companies.
Since insurance policies commonly contain such exclusions as part of any merger or acquisition resulting in assumption of liabilities, the acquiring company should conduct comprehensive due diligence to understand the litigation exposure presented by the target company.
Where there is significant litigation exposure, the acquiring company may be best served by retaining litigation counsel to advise on the nature and extent of that risk by using modeling and forecasting based on litigation trends, as well as to advise on the respective policy coverage to account for that risk.
In today’s market where mergers and acquisitions commonly serve critical functions as part of business strategies to accelerate growth and gain market share, it is not uncommon for such transactions to occur in increasingly condensed time frames.
It is also important for an acquiring company to evaluate its own corresponding policy coverage, as well as the coverage of the target company, to effectively protect against, or at least sufficiently mitigate, the exposure risks presented by the target company as part of any planned merger or acquisition.
PNC Bank Ruling
In PNC Bank, N.A., a nine-figure judgment was entered against the insured plaintiff in a prior proceeding. That judgment resulted entirely from fiduciary claims against a different bank, which the plaintiff recently acquired. The wrongful acts of the newly acquired bank preceded the date of acquisition. The insured plaintiff sought coverage for the judgment and defense costs under its banker’s professional liability policies. The plaintiff was denied coverage and brought a declaratory judgment action to compel its insurer to assume coverage.
The policy at issue defined “insured” in its professional liability coverage section to include both the insured and its predecessors in business. Conversely, the policy contained a “changes in exposure” provision which expressly excluded wrongful acts by newly acquired companies.
The pertinent portions of that provision read as follows: “[i]f, during the Policy Period… the Company acquires any organization . . . then coverage shall apply to such organization or entity and the Insureds of such organization or entity, but only with respect to Wrongful Act(s) committed, attempted, or allegedly committed or attempted, at the time of or after such event[.]”
The insured plaintiff’s first argument before the District Court relied on the contention that the changes in exposure provision restricted coverage only in circumstances where there was a surprise or snap acquisition. The insured plaintiff thus argued that since the acquisition at issue was not a surprise or snap acquisition, the coverage restriction did not apply. The District Court cursorily dismissed this argument based on the clear language of the carveout which made no reference to a “surprise acquisition.” In so ruling, the District Court refused to read in a “snap” or “surprise” element to this coverage restriction language.
The insured plaintiff next argued that definition of “insured,” as it appeared in the professional liability coverage section, included its predecessors in business, and therefore the policy must provide coverage for its loss that was attributable to the acquired bank, no matter the changes in exposure provision’s exclusionary language. The insured plaintiff argued that the professional liability coverage section was more specific than, and therefore took precedence over, the changes in exposure provision. The District Court again rejected the insured’s argument in finding that no actual conflict existed between the provisions. The 3rd Circuit upheld the District Court’s findings on each of these issues.
Takeaways
Ultimately, the 3rd Circuit’s opinion enforcing a policy exclusion for a target corporation’s prior bad acts reinforces the importance of conducting comprehensive due diligence prior to any merger or acquisition to fully assess the litigation exposure of any would-be target company.
Urgency in concluding merger and acquisition transactions should not come at the expense of neglecting the seller’s liabilities with respect to litigation exposure when those liabilities are assumed as part of the transaction.
- Acquiring companies should conduct thorough risk assessment of any target companies prior to entering into any merger or acquisition agreement.
- Depending on the complexity of the potential exposure, it may be necessary to retain litigation counsel to serve as consultants for purposes of fully and comprehensively determining the nature of the litigation risks, and the level of risk, facing the target company.
- Preparing an accurate risk assessment may require modeling and forecasting based on existing litigation facing the target company as well as litigation trends facing competitors and the respective industry as a whole. A comprehensive understanding of the legal landscape and trends will prove critical in this process.
Once a comprehensive exposure evaluation has been completed:
- It is equally important to understand any carveouts contained in the acquiring company’s insurance policy as it relates to the litigation exposure for that particular target company to determine whether the relevant policy adequately covers the risk.
- Assuming that prior wrongful conduct of a newly acquired company is excluded from the policy, as it typically is, the next step will involve evaluating whether the target company’s own insurance policy contains adequate coverage and policy limits to effectively protect against any litigation exposure.
- Where the target company lacks the appropriate coverage to adequately protect against its own litigation exposure, this may weigh heavily in the valuation of the target company or influence the decision by the acquiring company whether to make an acquisition in the first place.
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