2017 ABA Insurance Coverage Litigation Committee

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Gary Gilmore
5 years ago
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1 2017 ABA Insurance Coverage Litigation Committee March 3, 2017

2 Alexandra A. Roje Stephen P. Davidson Megan Shea Marc Sherman Leor Kaplan

3 R&W in typical private M&A agreement In absence of insurance, 10%+ escrow to protect buyer in event of a breach of a R&W Seller cannot distribute escrow funds for specified period Why use R&W insurance? Replace the escrow: Buyer s looks to the R&W policy (as well as seller to the extent of any escrow) and Seller has limited indemnification obligations Increase maximum indemnity/extend survival period Ease collection and fund concerns Manage jurisdictional issues (i.e., cross-border deals) Provide recourse when no seller indemnity possible (bankruptcy) Satisfy lenders requirements for additional security on transaction Streamlined underwriting process Confirmatory due diligence relying primarily on the insured to perform due diligence as it would in the absence of insurance Typically days from quote to binding.

4 Insures losses arising from covered breaches of reps and warranties (typically without regard to materiality) Policy period typically matches deal s survival period (up to 6 years) or extends survival period up to 6 years Premiums: 2%-4% of limits insured Deductibles Typically 1%-2% of transaction value (no indemnity deals may be higher) Escrow acts as deductible (drops down as escrow is released) Items not covered & exclusions Covenants, forward-looking statements, projections Known or scheduled matters Deal-specific concerns ( red flags in diligence reports) Reps and warranties typically excluded

5 Disputes often centered on quantum, but assessment of coverage issues can be an important part of the claims process Generally, insurers in this space consider their relationship with Insureds as a partnership Collaborative claims process Insured provides information freely Insurer works with the Claims personnel tasked with moving claim along in real time rather than waiting for the underlying case to play out First party vs. third party R&W claims Losses are the direct result of a breach Post-closing third party claims requires buyer to incur defense and indemnity costs

6 Estimated 25-33% of private M&A deals are using R&W Insurance Claims rate typically runs between 12%-17% Many claims do not breach the retention, but several have resulted in seven and eight figure payouts Common breaches allege issues involving financial statements, taxes, loss of key customers, IP, inventory, and product warranty/mislabeling

7 Established food & beverage company buys a competitor company run by its founders that makes a popular sports drink $280m purchase price on $40m EBITDA $2.8m indemnity escrow $25.2m R&W insurance policy

8 Financial Statements in accordance with GAAP No undisclosed liabilities All key contracts in order and not in danger of breach to parties knowledge Purchased assets are in good operating condition and repair, subject to ordinary wear and tear

9 Bottling equipment not in use at time of sale requires significant repairs costing roughly $3m A key customer walks away from its contract, and buyer finds s from the customer threatening to walk away unless certain issues are resolved to customer s satisfaction pre-sale Ordinary audit cycle reveals $1.2m in accounts receivable (A/R) that should have been written down prior to closing, affecting EBITDA for year at issue Former employee sues the company (now owned by the buyer) alleging that he is entitled to stock options; issue was not disclosed pre-closing.

10 Buyer notifies seller that it is making a claim against the escrow and wants to make a claim under the policy for the rest of its losses What happens now? What if there is no indemnity or escrow available?

11 Investigation Review the Purchase Agreement and identify the breach Review the policy Identify subject matter experts and counsel Collect back up documentation Quantify damages Notice to insurers Make sure notice complies with policy requirements Prepare notice based on information obtained to date even if not complete Include communications with sellers and status of indemnity claim

12 Insurer review Claims works closely with the underwriter who is familiar with the deal and the policy Is there a breach? Exclusions? Does Loss flow from the breach? Are multiplied damages appropriate? Differences in first vs. third party claims Use of outside counsel and experts Communication and negotiation Communications before written analysis Review ROR letter and provide additional information Prepare detailed proof of loss Parallel track with seller to resolve escrow issue Resolution (including dispute resolution)

M&A 2015 CONFERENCE INDIANAPOLIS JUNE 11

M&A 2015 CONFERENCE INDIANAPOLIS JUNE 11 1 What Goes Wrong After the Deal: Post-Closing Claims 2015 M&A CONFERENCE 2015 M&A CONFERENCE 2 Panelists David Barrett Partner Faegre Baker Daniels Scott Hebbeler