Selling a Business: Key Considerations for Professional Indemnity Insurance

Selling a business can be a complex process that requires careful planning and consideration. While most business owners can focus their attention on negotiations, contracts, and valuations, it is crucial not to overlook any insurance requirements during the sale transaction. This article will explore the importance of Professional Indemnity (PI) insurance when your client / the insured is selling their business and outline some key considerations.

Review existing PI Insurance

Before an insured enters into any business sale agreement, it is important to review their current PI insurance policy to understand whether the cover adequately protects against potential claims and liabilities following the sale of the business. This is because claims can still arise after a business has been sold.

In the context of your client selling their business, one of the important provisions to review in their PI insurance policy is the run-off clause.

Run-Off Clause Explained

PI insurance policies are written on a “claims made and notified” basis. This means that the policy only responds to claims which are made against an insured and notified to the insurer during the policy period, subject to any automatically included or optional extended reporting periods. 

Generally, PI insurance policies contain an automatic extension which places the policy automatically into run-off in the event the insured’s business ceases to operate or is sold to another person. When the PI insurance policy is in automatic run-off, it will continue for the remainder of the policy period but only covers claims arising out of acts, errors or omissions occurring before the insured’s business ceased operating or was sold.

Put another way, run-off cover is designed to cover claims that may eventuate after the insured has ceased operating or sold their business, but only for the professional services that were provided before the cessation or sale date. 

It is important to remember that selling a business does not prevent claims, complaints or demands being made by third parties in relation to professional services provided before sale of the business. This is why run-off cover should always be considered when sale of the insured’s business is contemplated.  

Beyond Automatic Run-Off Cover: Market Options

While automatic run-off cover applies until expiry of the insured’s current PI insurance policy period, you will need to think carefully about any further run-off cover that your client requires for subsequent periods. There are generally two (2) options available: annual run-off cover or multi-year run-off cover.

Annual run-off cover is negotiated with the insurer and renewed each year. Like any annual insurance contract, terms, conditions, premium and coverage availability can vary from year to year.

Multi-year run-off cover allows a predetermined run-off period to be prearranged, which means that the premium and terms and conditions of cover are locked in for an extended period, which could be up to seven (7) years.  Generally, the total premium is paid upfront and, in some instances,  multi-year run-off cover cannot be cancelled.

What is an adequate run-off period?

The actual period of run-off cover that your client requires depends on their specific circumstances but may be influenced by factors including:

• statute of limitations considerations;
• any run-off period obligation included in the sale contract;
• cost considerations;
• whether there are any mandatory industry requirements that stipulate the length of run-off cover that must be taken following the sale of the insured’s business.

Your client should also consider obtaining legal advice about the liabilities and obligations they may be exposed to with regard to their business, including any ongoing contractual obligations. This may assist to determine the appropriate period for run-off cover.

In addition to these factors, you will also need to stay up to date on the availability of run-off cover in the insurance market which can largely depend on insurer capacity from time to time. Some insurers may not be able to provide multi-year options.

Final Thoughts

The importance of run-off cover should not be overlooked. Keep the following in mind when talking to clients about sale of their business:

• It is best to start discussing run-off cover requirements with clients when they are considering selling their business

• Check your client’s current PI insurance policy to understand any automatic run-off cover they may already have

• If your client requires run-off cover for subsequent periods, it should be arranged before finalisation of the business sale and not later than the expiry of any automatic run-off cover under their PI insurance policy.

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Important Notice

Berkley Insurance Company (limited company incorporated in Delaware, USA) ABN 53 126 559 706 t/as Berkley Insurance Australia is an APRA authorised general insurer. Information provided is general only, intended for brokers and has been prepared without taking into account any person’s particular objectives, financial situation or needs. It is not intended to constitute legal advice. You should always obtain legal or other professional advice appropriate to your own circumstances. Insurance cover is subject to terms, conditions, limits, and exclusions. When making a decision to buy or continue to hold a financial product, you should review the relevant Policy Wording.