The preceding modules assumed a seller that leaves. That is the case with a fund, and it is not the most frequent case. In most mid-market deals the seller is the founder-manager, does not leave, reinvests part of the proceeds into the new structure and carries on running the business for the buyer. That single fact bends every mechanism studied so far, because the person who gave the warranties, the person whose knowledge is imputed and the person now running the asset are one and the same.
The first difficulty is evidential and it is immediate. Claiming under the policy requires establishing that the warranties were inaccurate, that is that the buyer's own chief executive misstated something. Even with a buy-side policy, where the seller is not pursued, the demonstration rests on documents held in the business he runs, gathered by employees who report to him, and on interviews the insurer will conduct with those same employees. This is not a question of loyalty: it is a question of structure, and it would exist with an impeccable manager.
The fraud carve-out, seen earlier as a clause of principle, becomes personal and live here. In a buy-side policy the insurer waives recourse against the seller except for that seller's fraud. If the investigation establishes that a practice was directed rather than inherited, the carve-out bites, and the insurer may personally pursue a man who still holds equity in the acquisition structure, occupies a management post and holds the customer relationships. The buyer then finds itself having to support, or at least not obstruct, an action against the person on whom the operation of what it has just bought depends.
The rollover complicates interests in both directions, and it is worth setting out properly because it is almost always stated by halves. On one side it aligns: the manager holds a share of the structure, so a breach that damages the business damages his own wealth, and he wants the venture to prosper. On the other it blurs: an indemnity paid to the acquisition vehicle increases its value, a fraction of which returns to him. He therefore partly funds the loss through his stake and partly receives its proceeds. Wordings almost never address that circuit, and at settlement it produces incentives nobody intended.
One knowledge point should be added to what was said elsewhere, because it holds only in this configuration. The manager stays, so his knowledge becomes that of an officer of the buyer from completion. A fact he knew before and continues to know does not become known to the buyer on a date the buyer could use: depending on the wording, the buyer may be deemed to have known it from the moment the individual became its officer. The notification period is thus shortened, sometimes consumed before anyone on the buyer's side had the information, and without anyone having intended that result.
Structures that handle this configuration properly do four things, and none is expensive if done at the right moment. They expressly separate, in the contract, the role of seller from that of manager, so that an action under the first carries no automatic consequence for the second. They place the duty to cooperate with claims on the company rather than on the individual, and they make it survive the end of his office. They impose document preservation on the company, which neutralizes the question of who controls the archive. And they provide that beyond a certain amount the claim is conducted by counsel instructed by the buyer's board rather than by the management team.
That leaves an honest observation an adviser should make aloud at placement, because it changes what the policy is really worth. This is the configuration where the product serves least, not because the wording is poor, but because using it costs something the buyer often values more: the goodwill of the person operating the asset. Many buyers do not claim for that reason, which amounts to holding cover they will not use. Saying so at placement allows it to be reflected in the deal price rather than discovered on the day one must choose between an indemnity and a chief executive.
A buyer acquires a specialist manufacturer for 70 million euros from three founder-managers. All three stay in post and together reinvest 20% into the acquisition structure. The policy is buy-side, with a 14 million limit and a 700,000 euro retention. Fourteen months after completion, the buyer establishes that product warranty provisions were systematically understated, understating liabilities by 2.8 million, and that the method was set by the finance director, one of the three founders, who also holds the relationships with the two largest customers. The breach of the accounts warranty is hardly in doubt and disclosure does not cover it. What does the buyer do?
The insurance question is easy and it is not the one that decides. The claim is good: breach established, 2.8 million above the retention, disclosure ineffective, so 2.1 million net to hope for. The difficulty lies elsewhere and must be set out in full. The documents proving the breach are held in the business the finance director runs, and the insurer will interview employees who report to him. Above all, once the investigation establishes that the method was set rather than inherited, the policy's fraud carve-out revives and the insurer may pursue him personally, while he holds a share of the structure, occupies a management post and holds the two largest customers. Claiming 2.1 million may therefore cost the finance director, the customer relationships, and the goodwill of the two other founders who are his co-sellers. The temptation is to treat this as a commercial judgment to be made at the moment of discovery. That is precisely the error: it is anticipated at placement, and it can be structured, through a contractual separation of the roles of seller and manager, a document preservation duty placed on the company, and conduct of the claim entrusted to counsel instructed by the board rather than by management. What the buyer must above all not do is notify, let the insurer's investigation implicate its finance director, and then withdraw: it would have damaged the relationship without recovering the money, which is the worst of both worlds. The decision is taken before notifying, never after.
- 01When the seller stays as manager, the person who gave the warranties, whose knowledge is imputed, and who runs the asset are the same person.
- 02Claiming requires establishing that your own manager misstated, with documents held by teams reporting to him: that is structural, not a question of loyalty.
- 03The fraud carve-out becomes personal: the insurer may pursue a man who still holds equity and the customer relationships.
- 04His post-closing knowledge may be imputed to the buyer, shortening the notification period without anyone having intended it.
- 05This is where the product serves least, because using it costs what the buyer values most: the decision is taken before notifying, never after.