Representations and Warranties Insurance

Transcription

1 Representations and Warranties Insurance Gaining Traction in the 2014 Marketplace April 2014 Lockton Companies Risk allocation lies at the heart of every transaction. Representations and Warranties Insurance (R&W Insurance) is increasingly being accepted by the merger CASEY ZGUTOWICZ Producer and acquisition community as a strategic alternative to traditional negotiation tactics. The use of this coverage has been growing steadily for the past few years. A key market saw a 40 percent increase in submission activity from 2011 to 2013, with the number of policies issued increasing 70 percent during the same time period. In the first quarter of 2014, insurers have been flooded with requests for R&W Insurance. The number of completed deals is on track to RENEE SZALKOWSKI Project Manager Risk Practices rszalkow@lockton.com LEAH COAKLEY Vice President Project Manager Liability Solutions lcoakley@lockton.com double by the end of R&W Insurance is an effective tool offered by insurers to facilitate the closing of a transaction. It is frequently used (i) in early stages of a transaction by bidders to distinguish their bid in an auction process, and (ii) in later stages of a transaction as a solution to facilitate a closing, which may have otherwise been prevented by a collapse in negotiations. This was originally published in Transaction Advisors L O C K T O N C O M P A N I E S

2 R&W Insurance protects an insured from losses incurred as a result of breaches of the seller s representations and warranties to the buyer in the sale agreement. Coverage can be provided to: A seller of a business for an indemnification claim made by the buyer resulting from a breach of the seller s representations and warranties. A buyer of a business in support or in lieu of a seller s indemnification obligation for breaches of their representations and warranties to the buyer. A party providing financing for a transaction. Strategic Uses of Representations and Warranties Insurance R&W Insurance can have a variety of strategic uses for a buyer or seller. In general, coverage can replace, attach excess, backstop, or extend the timeframe of an indemnity. Buyers frequently use R&W insurance to (i) offer a competitive bid on a business by requiring an indemnity with lower caps and survival periods than other bidders; (ii) supplement the indemnity provided by the seller; and/or (iii) ease concerns about collecting indemnity payments from the seller. Sellers frequently use R&W insurance to allow for distribution of sale proceeds at closing and/or protect passive sellers who are not willing or able to provide an indemnity. Common Reasons for Purchasing Coverage Buyer Seller Create a source of funds for an indemnity Supplement level of indemnification, e.g., excess of escrow Extend duration of the R&Ws Ease concerns about collecting indemnity payments Distinguish bid in an auction Lock in return Allow for a cleaner close to a transaction Expedite the distribution of sale proceeds Protect passive sellers Reduce obstacles to complete a deal 2

3 April 2014 Lockton Companies About Representations and Warranties Coverage R&W insurance was first introduced to the U.S. market in the late 1990s. At that time, premiums were high and coverage was limited. Additionally, the underwriting process was onerous. As a result, coverage was rarely purchased and only as a last resort when all other negotiation tactics had been exhausted. Today, R&W Insurance is increasingly used to respond to the needs of private equity and strategic buyers. Premiums are lower, coverage is more favorable, and insurers have streamlined the underwriting process. As a result, the product has also gained investment banks and attorneys as advocates. A claim is triggered upon discovery by the insured of a breach of a representation and warranty during the policy term, which follows the survival periods in the underlying agreement for representations and warranties, up to a maximum of six years. Limits purchased vary depending on the size of the transaction. Insurers offer up to $50 million in limits individually and up to $300 million as a market. Retentions are typically 1-3 percent of the transaction value, and the premium is based on a percentage of the limit purchased, typically 2-4 percent (or $20,000 $40,000 per million of limit). Standard exclusions include: Matters known to the insured. Purchase price adjustments. Representations and warranties that are forward-looking in nature. Consequential, special, indirect, multiplied, punitive, or exemplary damages or criminal or civil fines and penalties (carve-out for third-party claims). Currently, as part of the underwriting process, insurers will consider deleting the consequential and multiplied damage exclusions for an additional premium. Injunctive, equitable, or other nonmonetary relief. 3

4 Claims Examples Examples involving covered claims resulting from breaches of R&W include: Patent Infringement Accounts Receivable XX A seller-side policy responded to XX A buyer-side policy responded a claim brought by the buyer for to a claim for breach of financial breach of the seller s intellectual statements representation property representations and following a loss to the buyer warranties resulting from a as a result of $1 million of gift third-party claim of patent certificates not reflected on the infringement. target s balance sheet. To learn more about how R&W Insurance can respond in the event of a claim, you can review recent case studies at: Case_Studies_April_2014.pdf 4

5 April 2014 Lockton Companies About the Underwriting Process The underwriting process follows the timeline of the deal and can move quickly with insurers able to offer bindable terms within one week of receiving a request. The first step involves securing preliminary terms from insurance markets. Insurers require background of the target company, a draft of the sale agreement, and target company financials. There is no cost to obtain preliminary terms, which can be obtained within 48 hours of a request. If the insurer s preliminary indication is acceptable to the proposed insured, the insurer will move forward with more extensive underwriting upon receipt of a diligence fee that ranges between $15,000 and $25,000. The fee is a pass-through cost that the insurer uses to engage third-party counsel to assist with the underwriting process. Once the insurer is instructed to proceed to a full underwriting review, it requires access to the data room. Additionally, for a buyer-side policy, the insurer reviews third-party advisor diligence reports such as legal, financial, tax, and environmental. Upon review of such information, the insurer provides a revised policy draft (tailored for the deal) and an agenda for an underwriting call (to be held with the proposed insured and its advisors). Once the underwriter has completed its underwriting review and the terms and conditions of the policy have been agreed to by the insured and insurer, coverage can be bound at signing or closing. Insurers require a representations letter signed by a senior deal team member stating that no deal team members are aware of any claims. Insurers prefer transactions valued at $25 million and above. Most carriers require a $100,000 minimum premium to write a deal. 5

6 Conclusion Whether used from the onset of a transaction or in its later stages, R&W insurance can be an effective deal tool for buyers and sellers and provide a solid bridge to close. The product continues to evolve, and the increasing appetite of insurance carriers bodes well for the merger and acquisition community going forward. Both buyers and sellers should consider building it into the due diligence process for every transaction. 6

7 April 2014 Lockton Companies NOTES 7

8 Our Mission To be the worldwide value and service leader in insurance brokerage, employee benefits, and risk management Our Goal To be the best place to do business and to work Lockton, Inc. All rights reserved. Images 2014 Thinkstock. All rights reserved. g\white paper\zgutowicz, szalkowski, coakley\2014\zgutowicz_representations and warranties insurance_april 2014.indd:bew