Transaction Insurances

Transcription

1 Transaction Insurances 2014

2 What is it? Transaction liability insurance describes a series of non-standardised insurance products, which are specifically designed to remove particular risks from transactions. These insurances facilitate a deal where a particular risk is not acceptable to either party. 2 Transaction Insurances

3 Which risks can be mitigated? Provided sufficient information is available to understand a particular contingent liability, it is often possible to structure an insurance product to mitigate the potential liability by transferring the risk to insurers. Risks which can be addressed by insurance mechanisms include: breach of warranties and indemnities in the sale and purchase agreement for either the vendor or purchaser; environmental exposures; known litigation contentious tax issues and IPO liability for directors and officers. Warranty and indemnity insurance this can be obtained by either the buyer or seller to cover against non-performance of general or specific warranties in a sale and purchase agreement. Liability buyout caps or removes contingent liabilities and legacy management issues from a company s balance sheet. eg Litigation transfer/litigation gap for existing and pending litigation. a cap will provide catastrophe cover over and above the anticipated loss. Environmental insurance options include clean up cost cap, pollution legal liabilities and remediation. Tax opinion liability protects unanticipated deficiency in allowances for taxes and interest owed to a taxing authority including those attributable to a transaction or reorganisation. IPO Insurance protects directors and other signatories of a prospectus against claims for false or misleading statements. Benefits of transaction insurance Potential benefits will depend on the particular deal, however possibilities include: removing a deal breaking risk from the transaction and enabling the deal to close; providing either a vendor or a purchaser with a tool to use in negotiations. The objective for a vendor would be achievement of a higher sale price, and for a purchaser, mitigating risks assumed and; providing a mechanism to place a value on an otherwise unquantifiable risk, the costs of which may then be divided between the parties. Transaction size and insurance cost Transaction liability insurance can work for transactions worth $5 million to transactions in the hundreds of millions. The premium costs are typically a percentage of the limit of indemnity. The market for transaction insurance Transaction insurance is common in the UK and the US. It has become established in Australia over the past 12 years or so and is now relatively common, particularly in M&A transactions. There is a growing market for warranty and indemnity insurance in France, Germany, Japan, South Africa, South Korea, Australia and India. Types of transaction insurance warranty and indemnity insurance Warranty and indemnity insurance protects a buyer or a seller from financial loss resulting from a breach of warranty made by the seller in a sale agreement. Removes concerns about a seller s ability to meet warranty or indemnity obligations in the future. It is particularly effective when used to enhance a warranty cap, where negotiations with a seller are difficult, or to fill a warranty gap left by existing private equity vendors, who refuse to provide warranties. The term of the insurance cover usually runs concurrently with the duration of the warranty claim period in the sale agreement. Non-tax warranties usually last for two to three years. Tax warranties and indemnities usually last for six or seven years. The seller may wish to buy insurance cover for shorter period, because it expects any liabilities to become apparent in a shorter time frame and because the premium will be lower. Transaction Insurances 3

4 Warranty and indemnity insurance drivers purchaser Creates greater certainty in valuation and negotiations. Concern over seller s financial status / enforceability of seller s indemnity. Protection if cap on claims exceeded, up to agreed limit of cover. Extent of survival period and level of warranty. Avoid lengthy litigation following breach. Retain management focus on business. Reassure shareholders by reducing the risk of the deal. Supplements the due diligence process. Warranty and indemnity insurance drivers seller Make sale proceeds available by avoiding warranty-related escrow. Helps minimise any long tail of liability to facilitate a clean exit from the transaction for the sellers. The insurer will generally agree not to exercise any rights of subrogation against the seller in the event a claim is made unless there is fraud. Eliminates a potential obstacle to the completion of a deal. Obtain a higher sale price by transferring risk to the insurer (albeit this will usually be wholly or partially offset against the cost of the insurance premium). Protection from excessive liability for breach of warranty (prepare cleaner targets for auction process). Bridge any warranty gap. Demonstrate to shareholders a reduced risk in the transaction. Warranty and indemnity insurance cost Warranty and indemnity insurance is tailored for each particular deal and pricing reflects this. Premium rates have tended to fall over time as the market for W&I insurance in Australia has grown by the entry of new insurers. Premium is usually anticipated to be between 0.5% and 1.5% of the limit of cover. In setting the premiums, the insurers take into account a number of factors: the complexity of the transaction; the limit of liability when compared against the sale consideration; the scope of the cover agreed (for example, if certain exclusions are removed from the insurance policy, the premium may be higher); the financial stability of the parties to the deal; the industry sector; the geographical spread of business; the jurisdiction/governing law of the transaction; the level of retention and whether it is a tipping retention (ie whether once the retention is exceeded, the policy responds to cover the whole loss or only that above the retention); the quality of advisers involved (where they are of a high calibre, the insurers have greater comfort that a thorough due diligence exercise will have been carried out and that more liabilities will have been disclosed); the nature of the warranties and indemnities (the more specific they are, the lower the premium); the length of the policy period; the amount of the diminishment; and the cost of the insurer s due diligence. Who buys warranty and indemnity insurance? There are a number of parties to a deal who would benefit from buying warranty and indemnity insurance. These include: sellers of difficult-to-sell assets; private equity firms exiting from investee companies; private equity firms undertaking secondary buy-outs; listed entities buying from private equity firms; purchasers of financially distressed companies; transactions involving special purpose vehicles; sellers of family businesses; conservative buyers; conservative sellers; and sellers looking to reinvest funds received from a sale. Warranty and indemnity insurance cover Cover can be taken out for claims relating to breaches of any of the representations and warranties in the sale agreement and particularly claims arising as a result of breach of environmental warranties. These liabilities can be insured separately, if required, by a subset of the warranty and indemnity insurers or by environmental insurers. Buyers may focus on tax, intellectual property and environmental liabilities, and may wish to purchase separate or additional insurance to cover those areas. 4 Transaction Insurances

5 The cover structure will vary depending on the transaction. Cover may have minimum/maximum floor/cap. Occasionally part of the sale proceeds is held in escrow, thereby operating as an excess, with the parties insuring an additional amount on top; on other occasions it will sit above the de minimis claim threshold. While the insurance cover for breach of warranty/ indemnity is usually offered to cover breaches that occur up to the date of signing, insurers will often be asked to provide additional cover (known as new breach cover) to extend the insurance to cover the period between signing and completion. If a purchaser is anticipating a lengthy settlement period, for example as a result of the need to secure regulatory approval, then the need for this additional cover should be particularly considered. Warranty and indemnity insurance the insurance process The broker or underwriting agency will collect information about the transaction. The broker will obtain quotations from insurers and select the most competitive one for the clients. Where an underwriting agency is used it will provide a quotation. The insurer or underwriting agency will appoint lawyers to carry out a limited due diligence exercise and to review the warranties and indemnities. The due diligence exercise consists of a review of the due diligence report commissioned by the buyer, where available (and provided on a non-reliance basis). The review of the transaction documents is needed to determine whether the warranties and indemnities have been fully negotiated. Where the seller s liabilities are being insured, there is a risk that warranties and indemnities will be less closely negotiated than in a non-insured sale. Costs of the insurer s due diligence are payable by the potential insured, but are refundable if a policy is placed. The parties to the insurance policy in the sale and purchase agreement, their lawyers and the insurance broker will negotiate the terms of the insurance policy and ensure that it marries with the sale and purchase agreement. The insurance policy will be issued and the premium paid. In a competitive bid where a seller intends to stipulate the use of W&I insurance to transfer risk, it is usual for the seller to appoint the broker to obtain indicative insurance terms from interested insurers which are distributed to the prospective buyers. Once a preferred bidder is selected, the broker will be appointed by it to exclusively act on its behalf in negotiating and placing the insurance policy. Types of liability insurance loss mitigation coverage In the US, as well as in Europe, loss mitigation coverage is also available, providing insurance for known claims that are uninsured or underinsured. It could cover, for example, outstanding litigation, product liability and personal injury claims where the potential costs could be a huge variable. This type of insurance is used in private equity investments and public to private transactions, where it gives the buyer a much higher degree of confidence in controlling a potentially significant variable in its valuation model. Once the insurer has valued the claims, the target company s known expenditure will be the premium and any excess (if a claim is made). Like warranty and indemnity insurance, the loss mitigation insurance market is relatively new. Types of transaction insurance tax indemnities Another type of insurance used in sales of companies is cover for tax indemnity. Where the tax implications of a deal structure are not yet clear, the parties can, if they wish, insure the tax opinion. This could provide a welcome alternative to waiting and seeing how the tax authority classifies a transaction. Limits on cover Common exclusions from the policy (which can be negotiable): matters known to either party at completion; fraud of the insured party or losses from criminal acts; consequential losses; liabilities for non-monetary remedies; forecasts/forward-looking warranties; contamination/pollution separate policy; and inadequacy of business insurance cover. Transaction Insurances 5

6 How does it fit with the sale and purchase agreement? Transaction insurance sits outside the sale and purchase agreement it is essentially an external risk management mechanism between a party and the insurer. In some circumstances, it may be strategically preferable for a counterparty not to know about the insurance policy. For example, a seller negotiates to provide contentious warranties in exchange for an increase in purchase price, then covers its extra risk by taking out warranty and indemnity insurance or a buyer arranges warranty and indemnity insurance so that it can offer to buy the target without seller liability or with limited seller liability. The insurer will need to ensure that the sale and purchase agreement marries with its policy, that is, the warranty and indemnity risks in the sale and purchase agreement are as assumed in the policy. The sale and purchase agreement may need to deal with claim mechanisms and seller liability beyond that recovered from the insurer. Australian examples A multinational mining company was looking to transfer four contaminated sites to the government. The government would only provide an on-site environmental indemnity for two sites. An insurance program was developed to mitigate the off-site environment risk on these two sites and the on-site and off-site for the two sites. A company selling its manufacturing business agreed to provide the purchaser with most of the requested warranties in the early stages of negotiations. In so doing the vendor requested a higher sale price, which it achieved. The purchaser was unaware that the vendor had insured its potential liability pursuant to the warranties. A purchaser of one of three subsidiaries of a foreign plastics manufacturing business was concerned that if the vendor sold the third subsidiary there would be no assets to support warranty claims in the future. The purchaser and vendor agreed to an insurance mechanism to protect the warranties for a three year period rather than using the proposed escrow account. The costs were split between the parties. Private individuals selling a telecommunications business refused to provide an indemnity in relation to the treatment of a particular item for tax purposes. The vendors had positive opinions from their advisers, however there was a remote risk, which caused the deal to stall. A tax opinion insurance policy was structured to take the place of an indemnity and the costs were split in order to finalise the deal. A UK property investment company selling its Australian subsidiary wished to exit the Australian market with no trailing liabilities. A no warranties negotiation position would have resulted in a reduced sale price. The vendor was able to provide the warranties, not compromise on price and walk away from the Australian market with an effective and efficient deal. 6 Transaction Insurances

7 Talk to us Rehana Box Partner, Sydney Tel: Rehana is a leading advisor to the general and life insurance industry on regulatory compliance (including Insurance Act, Life Insurance Act, FSR, Privacy, Money Laundering and Insurance Contracts Act compliance), establishing Australian general and life insurance operations, reinsurance operations, distribution and agency agreements, and policy wording development and interpretation. Rehana has acted for insurers on major share and asset sales, privatisations, IPOs and business transfers (both between related and unrelated entities). Rehana is a leading adviser on the use of insurance in government and private contracts to underpin risk allocations including in PPPs, major government service and procurement contracts, construction and infrastructure projects. She is also a recognised specialist on directors and officers liability insurance and indemnities and a leading commentator in this area. A specialist on the use of warranty insurance, Rehana helps clients to use insurance as a replacement for contractual warranties. Rehana assists with insurance claim lodgement and negotiations with insurers. She audits the effectiveness of corporate programmes and contractual insurance and indemnity provisions. She also assists corporates with alternative risk transfer(akt), captive insurance and self-insurance arrangements. Rehana is recognised as a leading lawyer by: Insurance Chambers Global 2014 Band 1 insurance lawyer Insurance Chambers Global Asia Pacific 2013 Star Individual (the only insurance lawyer and one of only 10 Australian lawyers to achieve this ranking) Insurance Chambers Global, 2012 Outstanding Individual (the only insurance lawyer and one of only 10 Australian lawyers to achieve this ranking across all areas of law). APL and 2014 The Legal Practical Law Company Cross-border Insurance and Reinsurance Handbook 2011 endorsed as a highly recommended lawyer. Insurance Best Lawyers Australia, AFR 2010, 2011, 2012, 2013, 2014 Insurance Asia Pacific Legal 500, 2010/2011, 2011/12, 2012/13. EuroMoney 2014 Best of the Best 2014 rated one of the top 30 insurance lawyers in the world. Expert Guides Best of the Best 2014 Insurance and Reinsurance The International Who s Who of Insurance & Reinsurance Lawyers 2014 Transaction Insurances 7

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