Warranty & Indemnity Insurance – Strategic tool to help protect relationships post-closing

Geoffrey Lee : Australia and New Zealand Manager

Geoffrey Lee

Australia and New Zealand Manager

Warranty and Indemnity or Representations and Warranties (W&I) insurance is a strategic tool utilized in merger and acquisition transactions to transfer risk of financial loss for seller warranty breaches in a sale agreement to an insurer.

W&I has a number of well-known benefits for both buyers and sellers but the focus for this post is on highlighting where W&I could add significant value over uninsured deals in protecting ongoing business relationships between parties post-closing of a transaction. This is an area that is often overlooked but a crucial component of deal success.

In the event of a warranty breach, a buyer must consider the commercial realities of bringing a contentious action against the seller regardless of a claim’s legitimacy.  In many cases there is significant risk, particularly for public proceedings, that such an action could damage goodwill with management and employees or jeopardise existing relationships with established customers and suppliers of the business.  Particularly in the Asia context, saving ‘face’ and the concept of guanxi, where one relies heavily on social connections and networks, are fundamental values which permeate business relations and cannot be ignored post-closing of a transaction.  With a buy-side W&I policy, the insurer stands as a neutral and credit worthy third party to handle any potential warranty claims confidentially with the buyer.

Some common deal scenarios which W&I can help to address post-closing include:

Partial acquisitions

When a buyer acquires less than 100% of the business there will always be the need to manage on-going relationships between the new acquirer and existing vendors.  A warranty claim raises the potential for contentious disputes amongst the parties that could disrupt the post-integration process at a time when fostering goodwill with new business stakeholders should be a priority.

Founder divestments

Where founder led businesses are sold with existing obligations to work within the business post-completion, the drivers for its continued success are intrinsically linked to those providing the warranties under the sale agreement. Claims against the founder or management shareholders who are crucial to the business could be severely detrimental to the operation of the acquired business and its key customer and supplier relationships.

Large corporate divestments

In today’s economic climate, many transactions are undertaken to streamline businesses by divesting or spinning-off non-core assets.  Large corporate groups often require complex transitional service arrangements whereby buyers and sellers continue working together post-closing.  A warranty claim could sour this relationship and significantly impair the acquired business during this important transition period.

Joint ventures or mergers

Parties in a joint venture or merger seek to combine existing businesses to achieve a shared goal. In this situation a bespoke W&I solution can be structured so that both parties’ liabilities under the warranties in the merger agreement can be insured. This frees the combined management to focus their attention on the future success of the venture.

Warranty breaches in an uninsured transaction can put significant strain on relations where post-closing obligations between parties exist.  Accordingly, M&A participants should consider the value of W&I insurance as a risk mitigation tool in these common deal scenarios above. Beyond offering secure financial recourse for a buyer, a W&I policy may help provide additional peace of mind that important relationships can continue to be maintained well beyond the parties signing on the dotted line.

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.

Representations & Warranties Insurance Offers Certainty in Uncertain Times

Jonah Goldberg : Underwriting Counsel

Jonah Goldberg

Underwriting Counsel

Representations and Warranties Insurance (RWI) can provide certainty to buyers and sellers during uncertain times.  RWI is an adaptable product that can alleviate risk and provide strategic advantages for dealmakers as they navigate opportunities during the COVID-19 pandemic.  Liberty Global Transaction Solutions (GTS) is taking a proactive, commercial approach by underwriting transactions during the COVID-19 pandemic on a case-by-case basis, rather than applying blanket COVID-19 exclusions in all RWI policies.

RWI protects a buyer from financial loss related to an unknown risk arising out of a breach of a representation or warranty set forth in the purchase agreement.  The financial strength of the insurance carrier writing the RWI policy is paramount, as the financial loss of an unknown risk transfers from the parties to the transaction to the insurer’s balance sheet.  RWI can bridge the gap between the respective parties on risk allocation, thereby bolstering buyer and seller confidence in the terms of the transaction.

“We do believe that most businesses are impacted by COVID-19 in some way,” stated Brittani Marszalek, underwriting counsel at Liberty GTS, at a recent webinar sponsored by the Association for Corporate Growth.  During a period of extended economic uncertainty, deal dynamics and parties’ negotiating leverage are likely to change. Long settled clauses in purchase agreements (for example, the definition of Material Adverse Effect (MAE), absence of changes representations and material contract and customer/supplier representations) are now being carefully negotiated as parties consider the impact that the COVID-19 pandemic might have on these provisions, and how the associated risks should be allocated between buyers and sellers. We also expect that the mergers and acquisitions (M&A) market will generally start to become more buyer friendly as a result of the COVID-19 pandemic after a sustained period of a seller friendly market prior to the outbreak.  Some buyers may see opportunities to acquire businesses at discounted prices and there is likely to be increased activity in distressed M&A.  RWI will be a useful tool in the context of such transactions by providing buyers a source of recovery where one might not otherwise be available and potentially increasing the value of the distressed assets.

While we expect the M&A market may start to become more buyer friendly, RWI will continue to be a useful tool for sellers in M&A transactions as RWI can reduce or even eliminate the traditional need for the seller to establish an escrow account or purchase price holdback at the time of the sale to cover post-closing indemnification matters.  Depending on the length of the escrow period, sale proceeds could be tied up for years.  RWI, therefore, is attractive to sellers as it can facilitate a “clean exit,” allowing them to leverage their capital for other investment opportunities and/or to pay out investors.  According to a study by SRS Aquion Inc., of signed private deals between 2016-2018, with an RWI policy in place, the median size of indemnification escrows “averaged just 2.4% of the deal’s purchase prices… as compared to deals without such insurance averaged 11.4% of the purchase price” as reported by The Wall Street Journal.1

Liberty GTS’ ongoing commitment to the M&A market is robust and unwavering during these uncertain times.  Our approach is providing assurance to clients that insurance solutions will be driven by sound research, disciplined underwriting decisions and flexibility to customize RWI coverage designed to address the distinct characteristics of each transaction.

  1. Wall Street Journal, “May 5, 2020: Rep and Warranty Insurers Confront Coronavirus Risk”; https://www.wsj.com/articles/rep-and-warranty-insurers-confront-coronavirus-risk-11588633766 

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.

How could the downturn in the U.S. oil and gas industry impact M&A activity?

Angela Wu : Underwriting Counsel

Angela Wu

Underwriting Counsel

The oil and gas industry took another plunge in April 2020.  The underlying mood of the National Association of Production and Exploration North American Prospect Expo (NAPE), the industry’s largest upstream oil and gas congregation held in February 2020 in Houston, Texas, reflected a hunkering-down mentality in preparation for an impending downturn.  And, that was before the COVID-19 pandemic ravaged global economies.

The oil and gas industry largely consists of four major sectors: Upstream, Midstream, Downstream and Services, the last of which provides products and services that support aspects of operations for the other sectors.  As a result of advances in extraction technology and increased production, the domestic oil and gas industry has experienced significant growth nationwide.  As the industry boomed, investment opportunities in every segment of the energy sector abounded and interest from private equity firms increased dramatically.  Smaller energy-focused private equity companies also grew as need for private capital expanded.  At the start of 2020, the oil and gas industry represented 8% of GDP in the United States, supporting 10.3 million jobs, according to the American Petroleum Institute.1

Private equity investments, in general terms, focus on shorter term horizons, as opposed to strategically orchestrated transactions, which acquire businesses with the goals of consolidation and operational efficiencies.  As private equity firm investment in the oil and gas sector expanded, so too did the use of Representations and Warranties (R&W) insurance to protect against transactional risks in mergers and acquisitions.

R&W insurance is a tactical tool utilized in merger and acquisition transactions to transfer risk of financial loss for a breach of seller warranties provided in a purchase agreement to an insurance company’s balance sheet.  The insurance coverage can greatly reduce or replace the traditional need for the seller to set aside a large amount of money in escrow at the time of sale in order to cover post-closing indemnification needs.  Depending on the length of the escrow period, this may tie up capital for years.  R&W insurance is therefore attractive to private equity sellers as it can facilitate a clean exit, allowing the firm to leverage its capital for other investment ventures and/or pay out to investors as soon as possible.

What role will private equity now play amid the industry’s currently rapid downturn and how can R&W insurance play a pivotal role in offering transactional assurance?  As of Q1 2020, the industry saw oil prices trending at just below $50.00 per barrel.  Today, oil prices have sunk to some of their lowest levels in history as a result of 1) the Saudi-Russia price dispute; and 2) the far-reaching effects of COVID-19.  In March 2020, a price dispute erupted between Saudi Arabia, OPEC’s most influential member, and Russia, when the two countries failed to reach an agreement on supply cutbacks. Then, as both countries increased crude production dramatically, the ensuing supply glut caused oil prices to fall dramatically. At the same time, despite historically low oil prices, the world-wide COVID-19 outbreak stifled demand with airplanes grounded, people following stay-at-home guidance in every state, and economic activity generally subdued.  The combined effect of the dramatic increase in supply and the drop in demand caused WTI prices to close at a historic negative $37 per barrel on April 20, 2020.2 While this last plunge was the result of the characteristics of futures contracts and oil has since returned to positive territory, oil prices remain low. A recent Bank of America report projects that “demand will plunge by an average of 9.2 million barrels per day in 2020, more than double the originally projected 4.4 daily billion drop.”3  As of May 2020, the S&P 500 Energy Sector Fund (XLE) was trading down over 50% from a year earlier, as reported on the NYSE.

Oil and gas companies facing near-term debt maturities have likely either gone into bankruptcy or have hired restructuring advisors in advance.  Should oil prices not improve, thus restricting cash flows, a wave of restructurings and foreclosures could be expected.  Major lenders, such as JPMorgan Chase & Co., Wells Fargo & Co. and others, are reported to be setting up independent companies with management and operators in order to own and operate oil and gas assets after foreclosure.  If lenders decide to sell assets for pennies on the dollar instead of operate them, this environment would provide an invaluable opportunity for private equity and other investors with access to capital.  Such players will likely shift their focus to investing and acquiring distressed and deeply discounted assets.  In a distressed acquisition scenario, along with the traditional benefits received from R&W insurance, R&W insurance can, subject to terms, conditions and regulation: (1) backstop indemnities to increase the appeal of distressed assets, (2) remove the need to hold funds in escrow, which allows sellers to liquidate quickly; and (3) ease concerns regarding collection of funds from sellers that can be difficult or costly to pursue.

Carriers offering R&W insurance will be poised to respond with sound, disciplined underwriting standards designed to help offer protection and increase buyer confidence for unexpected transactional risks during the oil and gas industry’s projected systemic shift.

 

  1. American Petroleum Institute, “Energy Works Data”; www.api.org
  2. Forbes, “April 20: WTI At -$37, Brent At $26! What Happened? What Comes Next? The Stories That Will Be Told…”; https://www.forbes.com/sites/thebakersinstitute/2020/04/21/april-20-wti-at37-brent-at-26-what-happened-what-comes-next-the-stories-that-will-be-told/#16ec3e414d4b
  3. Bank of America Report, referenced by CNN, “April 13: Cheap oil isn’t going away, even after record production cuts”; https://lite.cnn.com/en/article/h_555e5ccb331690ff269b7f342cb6346c

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.

The importance of considering claims handling when selecting an M&A insurer

Simon Radcliffe : Claims Counsel

Simon Radcliffe

Claims Counsel

The M&A insurance market has become increasingly crowded in recent years due to the significant growth in the number of specialist MGAs (managing general agents) looking to capitalise on the increased appetite for the product and strong deal flow.

These MGAs, under pressure to establish market share, try and differentiate themselves both on pricing and scope of coverage.  It is important, however, for a prospective insured to step back and consider, before making a decision, how its claim will be dealt with if the deal does not go as expected.

The key point for insureds to understand in this context is that MGAs are not the risk-taker for the purposes of the policy and will usually have little or no authority to settle a claim, instead needing to refer settlements back to the panel of insurers that provide their capacity.  Some of these insurers might be completely new to the market, meaning that they have no prior experience of handling M&A claims and no track record of paying M&A claims.  Some might only stick around for a short period before exiting the market entirely, or deciding to provide capacity to a different MGA.  They are able to do this with relative ease because they have not invested in the people and infrastructure necessary to write the business directly for their own account.  This means that an insured can sometimes find that the entity handling its claim no longer has any ongoing interest in the MGA that wrote the risk and is more inclined, therefore, to take technical points.  The risk is that this can all combine to result in a protracted and unpredictable claims process, which is the last thing an insured wants when it is looking to recover and move forward as fast as possible following a loss.

It is essential, therefore, for an insured to give proper thought at the outset to which insurer or entity will be sitting behind its policy.  Making the right choice at this stage can save time and money down the line in the event that it becomes necessary to make a claim on the policy.  This is particularly the case in the event of a large loss.  An established carrier writing the business directly for its own account will have been through a claim of this nature before – it will understand the challenges involved and its claims handling team will be well equipped, therefore, to deal with them.  In addition, an insured will only have to deal with one decision maker throughout the claims process – a key consideration bearing in mind that both speed and clarity of response can be critical in this scenario.

There are increasing signs that the mindset of insureds is changing, with many placing an increasing amount of emphasis on the value of claims service when selecting which insurer to partner with.  This is especially noticeable for insureds who have already been through the claims process because they understand better than anybody that the failure to do so may result in buyer’s remorse.  This is no surprise – after all, the true value of a M&A policy lies in the ability of the insurer to deal with claims promptly when they arise and to honor them whatever their size.

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.

M&A insurance to support transactions in emerging jurisdictions on the rise

Gareth Rees : Chief Underwriting Officer

Gareth Rees

Chief Underwriting Officer

As global M&A activity continues to accelerate in regional markets worldwide, the use of transactional insurance has simultaneously increased.  In the past eighteen months, a clear trend has developed within the M&A insurance space.  We have seen rapid growth in the use of Warranty & Indemnity insurance in jurisdictions that, until recently, would not have been likely candidates for transactional insurance products.

Liberty GTS’s professionals have underwritten complex deals where the target business, or material component of it, has been located in jurisdictions including: Croatia, Ghana, Jordan, Kenya, Kuwait, Morocco, Niger, Romania, Serbia, Turkey and Uganda.  Buyers and sellers in emerging M&A markets such as these are taking the lead from market practice in jurisdictions such as the U.S., Western Europe and the Asia Pacific region by leveraging M&A insurance tools to facilitate satisfactory deal terms and outcomes.

Global M&A volume is at a 10-year high, according to the most recent EY Global Confidence Barometer, based on the annual survey of nearly 3,000 executives across 47 countries.  Deal appetite is being driven by innovation, disruption and the need for growth as buyers reshape asset portfolios to achieve greater scale and operational efficiencies.  The Global M&A market in 2018 was $4.1 trillion, up 16% from 2017.  In 2018, cross-border deal activity remained extremely strong, reportedly representing nearly 30% of the total global M&A market, which is an increase of 23% totaling $1.2 trillion as of year-end, as stated in the JP Morgan Global M&A Outlook report.

Despite economic and political uncertainties in emerging markets, both corporate and institutional buyers are seeking risk-reward investment opportunities by increasingly looking further afield.  The executives running the deals will likely have used W&I insurance in more “traditional” markets, where the product is now regarded as a normal part of the M&A transactional toolkit. They are now driving greater use of the product when conducting transactions in emerging markets, often with the same top-tier professional advisors, also familiar with W&I insurance, that advised them in more mature markets.

W&I insurance can actually be used to mitigate one of the actual or perceived risks of doing deals in emerging markets, namely unfamiliarity with the local court system.  The dispute resolution mechanism in a W&I policy, whether court-based or arbitration, need not match the SPA so, if that provides for local dispute resolution, the W&I policy can be used by a buyer to ensure that any warranty claims are dealt with in a forum and jurisdiction with which it is comfortable and familiar.

For insurers looking to grow their books, while it is positive that use of the W&I insurance is expanding into emerging markets, care must be taken to enter new jurisdictions prudently.  That can be achieved by insurers instructing advisors familiar with both the W&I product and the local market so that cover and commercial terms can be adapted to reflect any specific risks associated with transacting in these emerging markets.

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.