New Owner Review: Professional Liability (Errors and Omissions)

On the professional liability policy you inherited, check the retroactive date (the earliest date of work the policy covers) first. Most of these policies are claims-made, meaning they answer claims made while the policy is in force, so that date decides whether claims about the seller's past work are covered at all. Then check how the ownership change affects coverage for the seller's past work and the seller's tail (extra time to report claims after its policy ends), who controls settlement, whether defense costs reduce the limit, how the policy describes the services, and whether the limits meet your client contracts. Professional liability, also called errors and omissions (E&O), covers claims that the business's advice or services caused a client a financial loss, which general liability generally does not cover. This guide is for buyers of service businesses who want to know whether the seller's policy still protects them.

What does professional liability cover, and which policy answers a claim?

Professional liability covers claims that a mistake, oversight or failure to deliver in your professional services cost a client money, along with the cost of defending those claims. Think of a system design that fails or a missed code requirement. These claims usually fall outside general liability, which is built for bodily injury and property damage. See general liability vs professional liability.

The bigger difference for a buyer is the trigger. Most professional liability policies are written on a claims-made basis, not an occurrence basis:

See occurrence vs claims-made. Because professional liability forms are not standardized, every point below depends on your policy wording.

Will your policy cover the seller's past work after closing (the retroactive date)?

A retroactive date (the earliest date of work the policy covers) removes coverage for claims about work done before it, even if the claim arrives during the policy period. A seller who renewed continuously may have a retroactive date years in the past, and that date is what makes the current policy respond to a claim about a project finished long ago.

Covering a predecessor's prior acts is an underwriting decision, not a right, so settle it before closing if you can. For the deal mechanics, see prior acts and tail coverage after an acquisition and stock deal vs asset deal.

Who covers claims that arrive after the seller's policy ends (the tail)?

A tail, formally an extended reporting period, is a window after a claims-made policy ends during which a claim about earlier work can still be reported; it does not cover work done after the policy ended. In an asset purchase the seller often buys one, but it usually protects the seller's entity, not your company. Before closing, the seller should give its carrier written notice of any known complaints or circumstances; if the notice meets the policy's requirements, a later claim from those facts can be treated as made during the seller's policy. For who buys the tail, how long it runs and how the purchase agreement allocates these claims, see prior acts and tail coverage after an acquisition and the tail coverage glossary entry, and ask your deal counsel.

New claims-made policies usually exclude claims from facts or circumstances an insured knew about before the policy started, and the application often asks you to warrant that you know of none. Anything you learn in diligence, such as an unhappy client or a missed deadline, should be reported in writing to the seller's carrier before closing and disclosed on your own application, or it may fall between both policies.

Your own policy has notice rules too. Many professional liability policies are claims-made and reported: the claim must also be reported to the insurer during the policy period or any short window the policy allows, so report a demand letter or threatened claim promptly. The limit usually applies per claim and in aggregate, and the aggregate is shared across all of the business's work for the policy year, so one large claim can shrink what is left for the rest.

Who controls settlement, and do defense costs reduce the limit?

Two clauses change what a claim actually costs you.

• Consent to settle. Many professional liability policies say the insurer will not settle without your consent. Many also limit what the insurer pays if you refuse a settlement it recommends, often capping its share at the amount it could have settled for plus defense costs to that point, or splitting later costs with you by a set percentage. This is sometimes called a hammer clause. Read how strict yours is before a claim, because it affects your leverage with a client you may want to keep.
• Defense inside limits. In many professional liability policies, defense costs reduce the limit of insurance. A policy limit can shrink a lot during a long defense, leaving far less to pay a settlement or judgment. See defense costs inside vs outside limits.

Also note the retention or deductible, whether it applies to defense costs, and whether it applies per claim or in aggregate. A retention the business could pay once may be painful three times in a year. See deductible vs self-insured retention.

Does the policy describe the services the business really provides?

Professional liability covers only the professional services the policy defines. That definition is often written from the seller's application, sometimes years ago. If the business has added services, such as a consulting firm that now manages systems, those services may fall outside the definition. Plans for add-ons or new service lines raise the same question.

Read the exclusions too. Common ones include bodily injury and property damage (left to general liability), contractual liability beyond what you would owe anyway, fee disputes, promises of specific results, and data breach or network security claims, which often belong on a cyber policy. Some technology policies combine professional liability and cyber in one form; see the cyber insurance review.

Do the limits meet your client contracts?

Client contracts often set a professional liability limit, and some go further: they require coverage to stay in place for a number of years after the work ends, require a retroactive date no later than the contract start, or ask for notice if the policy changes. An ownership change that resets your retroactive date or switches the old policy into run-off can quietly put you out of compliance.

Remember that a commercial umbrella usually does not sit over professional liability, so higher contract limits normally mean a higher professional liability limit or a separate excess policy over it. If a key client contract asks for more than you carry, see when customer contracts require coverage you do not have.

What belongs on your professional liability checklist?

A hypothetical example. A buyer acquires a marketing agency in a stock purchase. The agency's claims-made policy has a $1,000,000 limit with defense costs inside it, a retroactive date eight years back and a services definition written from an old application: "advertising and marketing consulting." Since then, the agency has started building and hosting online stores for clients. The review finds that the change in control clause would switch the policy to run-off at closing unless the carrier agrees otherwise, and that the store-building work may fall outside the services definition. Before closing, the broker asks the carrier to confirm in writing that coverage continues for new work, to keep the existing retroactive date and to add web development to the services definition. The carrier agrees for an added premium. The buyer also raises the limit, because the largest client contract requires $2,000,000 and, with defense costs inside the limit, a long defense could use up much of a $1,000,000 limit before any settlement.

If you want a second look before or after closing, Morrow can review the professional liability policy and client contracts you inherited and request quotes where it makes sense; prior acts terms depend on carrier underwriting.

Keep reading

• Prior Acts and Tail Coverage After an Acquisition: Who Pays?
• Stock Deal vs Asset Deal: Whose Insurance Responds to Old Claims?
• When Customer Contracts Require Coverage You Do Not Have
• New Owner Review: Cyber Insurance
• Just Bought a B2B Services Company? Your Insurance Review Checklist
• All guides for new business owners

Frequently asked questions

Does the seller's professional liability policy cover claims about work done before I bought the business?

It depends on the deal and the policy. Claims-made policies respond to claims made while they are in force, about work after the retroactive date. In an asset purchase, the seller's policy and any tail usually protect the seller's entity, and your new policy covers the seller's past work only if the carrier agrees to prior acts. In a stock purchase, the company's own policy may keep covering that work through its retroactive date, unless a change in control clause switches it to run-off.

What is a retroactive date, and why does it matter after an acquisition?

It is the earliest date of work a claims-made policy covers. Claims about work before that date are excluded, even if the claim arrives while the policy is in force. If your new policy starts its retroactive date at closing, claims about the seller's earlier work are not covered by it.

Do defense costs come out of my professional liability limit?

Often, yes. Many professional liability policies pay defense costs inside the limit, so a long defense shrinks what is left for a settlement or judgment. Check the limits section of your policy, and if your client contracts require a set limit, ask your broker whether defense outside the limits or a higher limit makes sense.

Will my umbrella policy sit over professional liability?

Usually not. Commercial umbrellas typically sit over general liability, auto and employer's liability. Higher professional liability limits usually come from a bigger primary limit or a separate excess policy written over the professional liability policy.

Can I keep the seller's retroactive date on my new policy?

Sometimes. In a stock purchase the carrier may keep the existing date because the same entity continues. In an asset purchase into a new entity, covering the predecessor's prior acts is an underwriting decision. Ask for it in writing, before closing if possible.

References

• IRMI: Retroactive date definition
• IRMI: Extended reporting period definition
• IRMI: Prior acts coverage definition
• IRMI: Defense within limits definition
• Kilpatrick Townsend: Top 10 Things Corporate Attorneys Should Know About Insurance (Law360 reprint, 2016)

This article is general information, not legal, tax or financial advice, and not a coverage determination. Coverage depends on the actual policy wording, carrier underwriting, your purchase agreement and your contracts. Ask your attorney and accountant about deal and legal questions.