It has become increasingly more typical for IFA sellers to provide a wide suite of warranties and indemnities covering past advice claims, particularly where a business has a complicated or wide-ranging book of past advice (i.e. DBT transfers, VCTs, unregulated collective investment schemes).
Whilst this is more relevant to share sales (i.e. where the liabilities of the target company transfer with the target company), indemnities and warranties relating to past advice are still an ever-present part of business disposals that are structured as an asset sale.
Nevertheless, there are a number of protections that sellers can look to include in their sale to control the risk of past advice claims and mitigate the potential clawback against their proceeds.
Starting point – “No risk should be uninsured”:
A key safeguard for every trading IFA business is its professional indemnity insurance.
Whether the target company is being deauthorised and the business merged into the buyer’s group or remaining as an independent company post-completion, professional indemnity insurance (or a policy of run-off insurance) can play a key role in the risk mitigation exercise.
Sellers can consider requesting the following limitations to mitigate the risk of indemnity / warranty claims:
a) An obligation on the buyer to maintain a policy of professional indemnity insurance covering advice provided by the business prior to the sale (or run-off insurance where appropriate); and
b) An obligation on the buyer to pursue such indemnity insurance (or run-off) prior to or in conjunction with pursuing the sellers under the indemnities / warranties.
This helps protect a seller’s proceeds as it creates a separate destination for the buyer to recover its losses in respect of past advice claims as requires that the buyer pursues a claim under the insurance policy in priority (or in parallel) to the seller.
To the extent that the buyer’s claim under the policy is successful, any sums received will go towards reducing or extinguishing the seller’s liability under the warranties or indemnities (as applicable).
Note: It’s important to consider the terms of any proposed professional indemnity insurance or run-off as the policy will only be a useful protection to the extent that it covers what it needs to!
Commercial considerations for the parties to consider:
a) Which party is responsible for paying for the policy;
b) How long should the policy / obligation to maintain be effective for (particularly with reference to run-off insurance);
c) What control provisions should be in place to ensure the terms of the policy are not invalidated; and
d) Who is responsible for any excess on the premium in the event of a claim.
Time Limits – “A date to stop looking over your shoulder”
One way to manage and control the risk posed by past advice claims is establishing how long you will remain liable to the buyer for.
This can be done by introducing a “time limit” on the buyer bringing claims against the seller.
A time limit puts a long stop date on a seller’s liability for claims under the sale contract and in simplified terms, acts as a date whereby the seller can stop “looking over their shoulder” in anticipation of the buyer bringing a claim.
This operates so that the buyer is restricted from bringing claims against the seller after the expiry of the time period. Therefore, if a past advice claim was brought against the sold entity after the indemnity / warranty time period, the buyer would not be able to pursue the seller under the sale contract for the liability.
In this situation, assuming that the target has not been deauthorised, the buyer / sold entity would remain solely responsible for any liability arising from the past advice claim (but it would likely flow to the businesses’ professional indemnity insurance).
Therefore, agreeing a suitable time limitation is an important part of negotiations for both buyers and sellers.
The timeframe can be an arbitrary agreed date, or it can be linked to a number of factors, such as:
a) The period for which run-off / professional indemnity insurance is to be in place (so that the time limit is linked to the insurance limitation above);
b) The level of risk associated with the seller’s past advice book (i.e. DBTs); and
c) The purchase price structure, and the time period for paying any deferred / contingent instalments.
Closing Considerations:
Understandably, sellers will want to protect their consideration, but at the same time, buyers will want to protect their investment and reduce their exposure to claims relating to advice provided prior to its ownership.
As with anything, a fine balance must be struck between the parties, and consideration must be given to the facts and structure of each individual sale. Working with lawyers who are experienced enough in the financial services M&A market to be able to advise you on the market standards for these important seller protections is crucial here, so that you are able to negotiate a comfortable exit.
At Herrington Carmichael we have specialist Corporate Lawyers who can help you. If you would like to know more about selling your business, then contact us.