Insurance Products for Corporate Transactions

CORPORATE/COMMERCIAL

INSURANCE PRODUCTS FOR CORPORATE TRANSACTIONS

Corporate Transactions and Insurance. Hilary Griffith examines the increased use of insurance in mergers, acquisitions and other corporate transactions over the last few years.

When considering mergers and acquisition insurance, focus should be given
to the type of risk intended to be insured. These usually fall into one of two categories: unknown risks and known, but not yet quantified, risks including losses and pending claims.

Unknown Risks

In any transaction the buyer will try to establish what it is buying and will usually require from the seller a long list of representations and warranties as to the state of business and assets being sold.

There is however risk inherent in all corporate transactions - what happens if the representations and warranties are untrue either through fraud or mistake on the part of the seller? One traditional method which has been used in the past is to ask the seller to indemnify the buyer for breach of warranty. As with any indemnity, it is only as good as the financial solvency of the seller. Traditionally therefore buyers have sought comfort using a variety of methods, for example, parent company guarantees, retentions, escrows, deferred consideration and letters of credit.

W&I Insurance: Seller

M&A insurance can be very useful in these circumstances and can serve as the entirety of the seller's financial guarantee thereby removing the need for any of the methods mentioned above. If a seller's form of warranty and indemnity (W&I) insurance is obtained, the insurance will pay on behalf of the seller any indemnity obligations it owes to the buyer. However, the insurance can also be used in conjunction with a reduced retention, escrow or letter of credit.

W&I Insurance: Buyer

Alternatively, a buyer's form of W&I insurance can be obtained, whereby the buyer is covered by the insurance for a breach of a representation and warranty by the seller and the insurer subrogates itself to the buyer's rights against the seller for the breach.

Known/Not Yet Quantified

The buyer could in the course of its due diligence discover risks which are actually known but cannot yet be quantified or which are known to the seller but may or may not materialise. How can the parties "value" these risks in order to structure a transaction and move to completion?

M&A insurance can address such known risks by providing cover in excess of a self insured retention for losses associated with the risk. In this way, the loss is capable of being quantified being the amount of the self insured retention together with the insurance premium. Having quantified the loss, the parties can then negotiate where such loss should lie or indeed whether the deal should proceed at all.

Although all parties are generally usually aware that this type of insurance is being used, it is possible for one party to use such a product without the other party's knowledge. If, for example, a buyer discovers a potential risk during due diligence, it could go to the insurance market and obtain a quotation for insurance plus an estimate of the self insured retention that would be required. Armed with this knowledge, a buyer could negotiate a reduction in the purchase price with the seller which is greater than this figure thereby adding value
to the deal for the buyer. This is now happening so often that some insurance underwriters are calling for a different pricing model to be used so that they get a portion of the "value" added to deals by use of the insurance in this way.

Conclusion

This article outlines just some of the basics regarding M&A insurance. In conclusion, M&A products can be used to save a transaction where the parties cannot negotiate an appropriate form of indemnity or guarantee in respect of breach of warranty. However, it can also be used in conjunction with traditional methods as a "fall back" if something is missed in the course of the due diligence process. Finally, the products can in some circumstances add value to a deal where an identifiable risk cannot be quantified in any other way.

Hilary is an Associate in the firm's Corporate Department advising on a range of corporate and commercial issues. She recently advised SHS Group Limited on the acquisition of the British Pepper and Spice Company Limited and the Gourmet Garden business. Hilary can be contacted at hilary.griffith@lestrangeandbrett.com

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