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How the SRS acquisition ended in a lawsuit

When acquisitions take place in the insurance industry – a common event – there’s usually a brief flurry of announcements, followed by the acquired company getting back down to business under its new owners.

But things sometimes don’t go as expected, and the resulting legal fallout can be painful and revealing.

That’s what has happened between the former owners of Brisbane-based underwriting agency SRS and its acquirer, US broking giant Arthur J Gallagher.

Documents filed in the Queensland Supreme Court reveal a deal that has resulted in litigation over the interpretation of a clause in the contract under which SRS was sold.

SRS, the largest Lloyd’s underwriting agency in Australia, was acquired by Gallagher in November 2012. It was a significant move into Asia-Pacific by the global broker, whose Chairman, President and CEO J Patrick Gallagher described SRS at the time as “extremely well known in the industry for its market-leading expertise, innovative products and first-class claims service”.

Yet within three years SRS founder Paul Lynam was gone from the business and Gallagher’s regard for its acquisition had soured somewhat. Now Mr Lynam and five other people – the former shareholders of SRS – are suing Gallagher through their various family trusts for $3.6 million they believe is owed as the final “earnout” from the sale.

The reasons behind the dispute are complex, but Gallagher’s $1.01 billion purchase of OAMPs in April 2014 – just 17 months after buying SRS – allegedly placed its star underwriting agency at an unexpected commercial disadvantage and is now seen as the catalyst for this impasse.

The OAMPS acquisition resulted in a profound shift in the formerly positive relationship SRS enjoyed with major international brokers in the local market.

Sources have told insuranceNEWS.com.au the SRS business was abandoned by the major brokers, who now saw Gallagher as a significant competitor in the local market. With them went a major slice of the SRS business.

Mr Lynam, who had been placed in control of SRS and fellow Gallagher-owned underwriting agency Australis under the new Pen Underwriting brand, departed the company in December 2015, saying he had left “following redundancy”. Key members of his former SRS operation also left Gallagher over the following year.

Having completed his non-compete agreement with Gallagher, Mr Lynam has now joined the Sydney-based Epsilon underwriting agency as Chairman.

His Chief Underwriting Officer at SRS and Pen, Paul O’Leary, has taken up the same position at Epsilon. Mr O’Leary is one of the parties in the action against Gallagher.

insuranceNEWS.com.au understands that none of the senior international Gallagher executives who negotiated the acquisition are still with the company.

Gallagher has not yet responded to the plaintiffs’ court filing, although it is understood to haven declined mediation. No date has yet been set for a hearing, and a spokesman told insuranceNEWS.com.au today it would not be appropriate for the company to comment while the matter is going through the legal process.

Mr Lynam, who was the principal SRS shareholder, declined to discuss the history or technical details of the case when contacted last week by insuranceNEWS.com.au.

He would say only that he is “disappointed it’s come to this”, and that the plaintiffs intend to subpoena the former Gallagher officers who negotiated the sale.

That would include former international division CEO David Ross, now CEO of UK insurance group Towergate, and who was himself the target of litigation in 2015 after he left Gallagher. Towergate agreed to pay the US-based broker £20 million ($32.81 million) in damages for poaching Mr Ross and several other senior executives.

The SRS action in the Queensland Supreme Court revolves around negotiations over the purchase of SRS, which carried an “earnout” provision that is now claimed to have been interpreted in a way that was not intended, and which, as a result, has enabled Gallagher to avoid paying the partners any of the final payment.

The earnout agreement covered the period from January 1 2013 to December 31 2015. It was to be calculated on profit commissions –  an incentive payment from underwriters that acknowledges low claims rates over the life of a policy.

While general commissions are usually paid at the end of each reporting period, profit commissions are paid in a range from three years after the first premium is paid to as much as seven years after the last premium is paid.

The court documents show that under the purchase agreement the parties agreed to a complex formula based on earnings before interest, tax, depreciation and amortisation (EBITDA), as well as profit commissions for 2013, 2014 and 2015.

The maximum earnout amount that could be due to the SRS partners on December 31 2015 would be $8 million.

However, on May 10 last year Gallagher supplied the plaintiffs with a statement saying the earnout EBITDA amount was $17 million and the earnout profit commission was $3.6 million. Gallagher calculated the amount to be paid as the earnout was zero.

The plaintiffs maintain the earnout amount calculated from EBITDA and profit commissions cannot be set off against each other.

They say the formula used by Gallagher was never discussed during the share sale agreement negotiations, with the focus instead being on whether to use calendar or financial years in the calculation.

The plaintiffs also claim Gallagher breached conditions of the sale agreement by “failing to use reasonable endeavours to promote and support the business and the SRS Group during the earnout period”, losing them the opportunity of receiving the earnout commission.

These “reasonable endeavours” are listed as: Gallagher failing to integrate the business with other underwriting agencies it either owned or controlled; failing to enforce its own “vertical integration strategy” for the SRS business; and not rationalising the SRS cost structure to reduce expenditure.

They claim that if these steps had been taken, there was a “100% chance” the earnout payable to them would have been $3.6 million.

Alternatively, they are seeking damages for breach of the sale agreement, plus interest.

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