Buying or merging with another firm? You are acquiring its PI liabilities too

Professional services are consolidating quickly. Accountancy in particular has seen a sustained run of dealmaking, much of it backed by private equity drawn to a fragmented market, and law, surveying and consultancy firms are combining for scale, succession and technology in the same way. For a managing partner or finance director, the financial and cultural due diligence on a merger or acquisition is usually thorough. The professional indemnity position often is not — and it is one of the few parts of a deal that can hand you a liability years after the ink is dry, for work your firm never did.

The reason is the way professional indemnity responds. It is written on a claims-made basis: the policy that pays is the one in force when a claim is first made or a circumstance is notified, not the one that was in force when the advice was given. So the question in any combination is not “whose work was it?” but “whose policy is on risk when the claim arrives?” — and the answer to that is something the two firms, and their insurers, decide at the point of the deal.

The liability that is not on the balance sheet

Every established firm carries a tail: the body of advice, reports, filings and transactions it has produced over the years, any of which could still generate a claim within the relevant limitation period. On a going concern that tail is managed quietly by renewing cover each year, because a current policy stands ready to meet a claim whenever it is made. The moment a firm stops renewing — because it has closed, or been absorbed into a buyer — that quiet arrangement ends, and the tail becomes a live question: which policy is now on risk for all of that past work?

This is why a professional indemnity liability rarely shows up cleanly in the accounts you are reviewing. A target with a modest balance sheet and a clean recent year can still be carrying years of exposure from past engagements. The claims that test a professional’s cover are often the slow-burning ones — a transaction that unwinds, advice that is only tested when something downstream goes wrong — and they can surface long after the firm that gave the advice has been folded into yours.

Who pays for the past: run-off, or your own programme

There are two honest ways to make sure the target’s past work stays covered, and a deal needs to land on one of them deliberately.

The first is run-off cover: the target keeps its own policy alive, in a closed form, to answer claims that arrive after it stops trading. Run-off does exactly what is needed — it ring-fences the old firm’s liabilities on the old firm’s insurer — but it is a substantial one-off cost, and someone in the deal has to agree to buy it and pay for it. Who bears that cost is a point for negotiation, not an afterthought.

The second is to bring the target’s past work onto your programme, so that your policy picks up claims arising from its historic advice. In insurance terms this usually means extending your cover to assumed liabilities and setting the retroactive date for that acquired work far enough back to catch the whole tail. Insurers will do this, but only if asked, only if they have seen the target’s claims history, and usually for an adjusted premium — it is additional exposure they are being asked to take on. What you must not do is assume it happens by default. A standard policy will not silently cover another firm’s past work just because you have bought the firm.

For solicitors, the choice may already be made for you

Solicitors’ firms are the important exception, because the position is written into the rules. The Solicitors Regulation Authority’s Minimum Terms and Conditions — the compulsory wording every solicitor’s policy must contain — use the concept of a successor practice. If your firm takes over another firm’s practice in a way that makes you its successor practice, your insurer can be obliged to cover claims made against the firm you took over, whether or not you ever intended your programme to carry them.

The ceasing firm can prevent that by electing to go into run-off under its own policy on cessation — but the SRA rules require it to do so, and to pay the run-off premium, before it stops practising. If it does not, the successor practice’s insurer is the one left on risk for the old firm’s past work. The run-off itself runs for six years from the expiry of the ceasing firm’s last policy, with a longer-tail backstop arrangement for the occasional claim that surfaces later still, reflecting the long limitation periods under the Limitation Act 1980.

The practical point for a solicitor-firm buyer is blunt: you may inherit the target’s liabilities on your own policy by operation of the Minimum Terms, so you need to know before completion whether you are a successor practice, whether the target is going into run-off instead, and who is paying for whichever route the deal takes. The SRA’s own definition of successor practice is detailed and has been the subject of professional debate; where a deal is finely balanced it is worth confirming the position with your broker and, if needed, specialist advice rather than assuming.

For other professions, nothing is automatic

Accountants, surveyors, architects, engineers and management consultants have no equivalent of the solicitors’ successor-practice machinery. Their regulators and professional bodies — the ICAEW and ACCA, RICS, the ARB and others — require firms to hold adequate professional indemnity cover while they are trading, but there is no rule that automatically moves a closed firm’s liabilities onto a buyer’s insurer. For these firms the position is governed by two documents: the professional indemnity policy wording, and the sale or merger agreement.

That is a freedom and a trap. The freedom is that you can arrange the cover to suit the deal. The trap is that if no one arranges it, the tail can fall into a gap — the target stops renewing, buys no run-off, and your policy was never extended to pick up its past work, so a claim that arrives afterwards finds no live policy at all. Whether you are buying shares (in which case the company’s liabilities generally travel with it) or assets (in which case liabilities may in principle stay behind, though disgruntled former clients will still come knocking) changes the legal analysis but not the underlying need: the past work has to have a policy standing behind it, and that has to be arranged, not assumed.

Tell your own insurer — it is now a different risk

A merger or acquisition changes the firm your insurer agreed to cover. Under the Insurance Act 2015 you owe a duty to make a fair presentation of the risk, and an acquisition is squarely the kind of material change an insurer expects to hear about — ideally in advance, not at the following renewal. The enlarged firm has new work types, a new claims history folded in, more fee income and often a different client profile, all of which bear on the cover and the premium.

Two technical points are worth putting in front of the board. First, limit adequacy: a limit that was comfortable for either firm alone may be thin for the combined entity, whose single largest exposure is now larger. Second, aggregation — the way related claims are treated as one for the purposes of the limit — can behave differently once two books of work sit under one policy, particularly if both firms acted on the same matters or the same clients. Neither is a reason not to do the deal; both are reasons to have your broker model the combined programme rather than carry two old assumptions into one new firm.

What to settle before completion

The professional indemnity side of a combination comes down to a handful of questions a finance director or managing partner can own, none of which needs technical insurance knowledge to ask. What is the target’s claims and notification history, and has it been disclosed to your insurer? Is the target’s past work going to be covered by its own run-off, or picked up on your programme — and if the latter, from what retroactive date, and at what premium? For a solicitors’ deal specifically, are you a successor practice, and if so is run-off being taken out instead? Who, in the sale agreement, bears the cost of run-off and warrants that all known claims and circumstances have been disclosed? And does the combined firm’s limit, and the way claims aggregate against it, still make sense for the larger business you are creating?

Settle those before you sign and the insurance tail becomes a line item you have priced and placed. Leave them until the integration is done and you risk discovering, when a claim arrives for work done by a firm that no longer exists, that no policy was ever arranged to meet it. That is the one outcome a well-run deal should never reach.

Frequently asked

We are buying the shares of the target, so don’t its liabilities — and its insurance — just come with it?
The liabilities generally travel with the company on a share purchase, which is exactly why the tail matters. But the insurance does not automatically keep pace. The target’s policy will still lapse at its next renewal unless someone keeps it alive as run-off, and a claims-made policy only pays while it is live. So even on a share deal you need a positive decision — run-off on the acquired company, or an extension of the group programme to cover its past acts — rather than an assumption that cover came along with ownership.

Is run-off always the safer option than bringing the work onto our programme?
Not always — both can work, and the right choice depends on the deal. Run-off ring-fences the old firm’s liabilities on the old firm’s insurer, which is clean, but it is a significant one-off cost and leaves you managing a second, closed policy. Bringing the work onto your programme can be simpler to administer and keeps everything under one roof, but it adds the target’s history to your own record and depends on your insurer agreeing the extension and the retroactive date. The point is to choose deliberately, with your broker, and to make sure the sale agreement says who pays for whichever route you take.

We are a solicitors’ firm absorbing a smaller practice — is there anything we must not miss?
The successor-practice rules in the SRA Minimum Terms are the thing to get right. If you are the successor practice and the ceasing firm does not put itself into run-off and pay the premium before it stops practising, your insurer can be left covering its past claims. So establish, before completion, whether you are a successor practice, whether the other firm is electing run-off instead, and — in writing, in the agreement — who bears that cost. Because this turns on a defined term and has been argued over in practice, confirm the position with your broker rather than relying on a general understanding of how it “usually” works.

Apex Insurance Brokers Limited is authorised and regulated by the Financial Conduct Authority (FRN 724952). This article is general information, not advice on a specific policy.