answers to your E&O questions
E&O and other considerations when
buying an agency or book of business
The E&O report by Keidel, Weldon & Cunningham, LLP
During the past year or so, we have seen a large
increase in the number of agencies acquiring other
agencies or purchasing books of business from
other agencies or brokerages. There has also been
a noticeable increase in the mergers of insurance
agencies and brokerages. Our firm regularly
handles these types of matters and, as such, we
understand the details and concerns that must
be considered by both the selling and purchasing
entities before and during any acquisition process.
In this article, we will review some of the E&O
and other important issues that can arise when an
agency looks to enter into a buy/sell transaction
involving another agency or brokerage, whether in
whole or in part.
However, along with the purchase of all the
selling entity’s assets in a stock transaction, the
purchasing entity also assumes all the liabilities
of the selling entity. This includes any tax liability
and any potential errors and omissions liability
incurred by the entity being sold, and any such
liability will become the new owner’s responsibility.
Accordingly, the existing or contingent liabilities
of the selling entity must be fully disclosed and
carefully scrutinized by the purchaser in any such
transaction. Appropriate indemnification provisions
are important to protect the purchasers from future
claims of liability which the sellers may have honestly
overlooked or may have been unaware of at the time
the agreement to sell was executed.
types of purchasing agreements
The type of purchase agreement and the contents
of such an agreement vary from transaction to
transaction. However, there are basically two types
of purchasing agreements used in connection with
the purchase or sale of an agency or a brokerage:
a stock purchase agreement and asset purchase
agreement. There are substantial differences
between the two types of transactions. When buying
a book of business, the transaction is more akin to
an asset purchase agreement.
Tax considerations must also be addressed
in advance of entering into a stock purchase
agreement. Most, though not all, insurance agencies
incorporated as stock companies are classified
as Subchapter S corporations, meaning they are
“pass through” entities for tax purposes. The
profits and losses realized by these companies are
passed through to the owners in proportion to
the percentage of ownership of each owner. Such
entities file federal tax returns for informational
purposes only and do not pay federal income tax.
Relevant tax rules differ from state to state.
Stock Purchase – This type of transaction involves
the purchase of the shares of stock of the selling
corporation – in other words, a purchase of all
the selling entity’s business. There is no need to
list the particular assets that are being purchased
in this type of transaction, since by definition a
stock purchase includes all assets owned in the
name of the selling entity. One or more of the
new stockholders are replacing the previous
stockholders in the selling entity, or a new entity
can be created to purchase the stock.
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Asset Purchase – An asset purchase is the more
frequently used method for the purchase of an
agency/brokerage or book of business. In an asset
purchase agreement, the purchaser is only acquiring
a particular list of assets from the seller for a specific
price. This type of transaction generally includes the
book of business of the selling entity, along with any
goodwill associated with that business. The sale need
not include all of the selling entity’s assets, although
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