How can Lawyers Professional Liability (LPL) insurance coverage best be addressed when two or more lawyers or law firms combine their separate practices into a single new firm? Three basic approaches merit consideration:
The first option, which is the most expensive, would involve purchasing an extended reporting period endorsement (Tail coverage) from the existing carriers for each of the predecessor firms. The new firm would then purchase a less expensive "no prior acts" policy, which would only apply to claims arising out of work performed by or on behalf of the new firm. Typically, a policy not covering prior acts runs about half the cost of a policy covering full prior acts. The cost of the policies for the new firm would normally increase over time because of the step rate increases applied at each successive renewal due to the increasing prior acts exposure. The increases normally cease sometime between the fifth and seventh year of coverage when the policy is deemed mature. All things being equal, a mature policy, whether it covers 5 years of prior acts or 25 years, would cost the same.
The advantages of each predecessor firm purchasing a tail is that the new entity would not be exposed to claims arising out of work performed by either of the predecessor firms. The main disadvantage is the expense. Typically, a tail endorsement would cost approximately 100% of the expiring premium for a one year term, 150% for two years, 185% for three years and approaching 300% for an unlimited tail. The exact factors used differ from carrier to carrier. In addition, Some carriers offer very limited tail options. For example, the maximum duration tail available from the existing carrier may be three years or less. The insureds may not be comfortable with a tail that is so short. Also, once a tail is purchased, even if it were for an unlimited duration, normally the total available limits are the limits in force on the expiring policy to which the tail endorsement attaches. With tail coverage, you typically do not get fresh, replenished limits of liability at each policy anniversary as you would with a normal policy. A few carriers do, however, offer annually renewable tails which may provide a new limit of liability each year depending on the carrier's preference.
The second approach is similar to the first, except one of the merging firms survives as a going concern and does not purchase tail coverage. Under this method, the attorney(s) from the other firm(s) would be "hired" into the surviving firm, which would simply add those attorneys to its policy mid-term. The surviving firm could change its name to accommodate the new entrants so long as the firm remains the same legal entity. Even with a name change, the new attorneys would only be covered for work performed on behalf of the new firm, so tail coverage would be necessary to address the prior acts exposure of those attorneys. This method would normally be less expensive than one which contemplates all merging firms buying tails and then a new policy for the newly created firm.
The third and final method for addressing the LPL insurance needs of merging firms does not require the purchase of tail coverage by any of the firms involved. The key to this approach is qualifying the one or more firms as "predecessors" to the surviving successor firm. A typical definition of a covered predecessor firm may read as follows:
"Predecessor in Business" means any legal firm which has undergone a material change as follows: (a) some or all of such firm's principals, owners, officers or partners have joined the Named Insured, provided such persons were responsible for producing in excess of 50% of the prior firm's annual gross billings and such billings have been assigned or transferred to the Named Insured; or (b) at least 50% of the principals, owners, partners or officers of the prior firm have joined the Named Insured; or (c) at least 50% of the prior firm's financial assets/liabilities have been assumed by the Named Insured.
One disadvantage of this approach is that the successor firm's LPL policy would become exposed to claims arising out of a predecessor firm's activities, which may have occurred years before the merger. Depending upon the severity of any such claim, this could cause a substantial increase in the successor firm's cost of insurance.
Another problem arises from carriers' differing predecessor firm definitions. Most carriers will only afford coverage for predecessor firms if the successor is the majority successor in interest, but some require two-thirds. Some few only provide predecessor coverage by endorsement or not at all. So, if the successor firm changes carriers following the merger, the predecessor firm coverage could be compromised.
In sum, there are pros and cons to each varying approach to the LPL coverage needs of merging firms. If you find yourself in such a situation, please feel free to contact a Dominion representative to further discuss your options.