R&W Insurance as a Tool for
Strategic Buyers and Sellers
Association of Corporate Counsel
December 12, 2016
CONFIDENTIAL
© Copyright Baker Botts 2016. All Rights Reserved.
Agenda
01
Background and Market Trends
02
R&W Insurance Policy Nuts and Bolts
03
R&W Insurance as a Tactical Tool
04
Conclusions and Q&A
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2
BACKGROUND AND
MARKET TRENDS
01
3
Overview
•
What does Representation and Warranty (R&W) Insurance cover? How
much of the typical indemnity and escrow/holdback framework does it
replace?
•
What are typical pricing terms?
•
What are the steps to obtaining a policy?
•
How does the post-closing claims process compare to a typical indemnity
claims process?
•
When might it be in the interest of a strategic Buyer or Seller to use R&W
Insurance?
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4
Recent Growth in the R&W Insurance Market
•
Concept of R&W Insurance has existed for more than 20 years, but market
only began to develop in a significant way more recently
– Buyers reluctant to rely on what they viewed as an untested product
– Pricing terms were prohibitively high in many cases
•
U.S.-based buyers would encounter it occasionally in acquisitions involving
European targets
•
Significantly more insurance capital available in the last five years
•
Pushed in the U.S. by private equity sellers
– Desire to pay proceeds to limited partners quickly and without risk of clawback
•
Also becoming popular with risk-averse sellers (founders/individual sellers)
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Strategics Making Greater Use of R&W Insurance
•
Use of R&W Insurance by strategic Buyers and Sellers has grown
substantially in the past two years
•
Previously 80/20 PE/Strategic; now closer to 60/40
•
Not just strategic Buyers being mandated to use by PE Sellers
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6
Role of R&W Insurance in an M&A Transaction
•
R&W Insurance covers liabilities arising out of a breach of one or more of
the R&W made by a Seller in the purchase agreement
– This is risk that would ordinarily be allocated to the Seller, subject to negotiated
limitations
•
Structure (including Seller indemnity and Buyer deductible) depends on
objectives of parties
•
Policies can be designed to supplement Seller indemnification obligations or
function as Buyer’s sole source of recovery
•
More commonly associated with mid-market M&A transactions but can be
used in connection with $1B+ deals
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Insurers Now in the R&W Market
•
600+ policies underwritten in the U.S. in 2015 industry-wide
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R&W INSURANCE
POLICY NUTS & BOLTS
02
9
Typical Indemnity Framework
•
Private transactions involving strategic Buyers and Sellers historically have
relied on a customary indemnity framework
•
Seller makes a variety of R&W to the Buyer about the condition of the
business or assets being sold
•
Usual post-closing recourse for R&W breaches is the Seller's indemnity
•
Buyer might insist on escrow/holdback arrangement depending on
creditworthiness of Seller
•
Indemnity framework generally highly negotiated
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10
Common Focuses of Negotiation
•
Sellers seek to limit liability
– Narrowed scope of R&W, qualified by materiality or knowledge
– Short survival period for many R&W
– Lower caps on overall liability and larger baskets before indemnification
obligation is triggered
– Higher thresholds before a Buyer can bring a claim
•
Buyers seek comfort they can recover for significant claims
– Holdbacks and escrow arrangements provide security for a buyer's claims but a
seller may be resistant to tie up a significant portion of sale proceeds for an
extended period of time
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Typical Terms and Conditions (1/2)
•
Coverage is for financial losses resulting from a breach of a R&W
– Separate from other transactional liability insurance (e.g., tax position insurance
and known contingent liabilities)
•
Policy can cover all R&W, including general, fundamental and tax R&W
– Certain R&W (e.g., environmental) may require additional diligence by the
insurer and can affect the premium
– Typical exclusions include fines, penalties and taxes (even if included in contract
definition of damages); terrorism, war, etc.; and pollution
– Consequential and multiplied damages: follow silence with silence
•
Can provide for longer survival period than in the purchase agreement
•
Coverage is 3 years for general R&W and 6 years for fundamental and tax R&W
•
If there is a particular R&W (e.g., IP) that a Buyer wants to convert to a
fundamental R&W, that can be covered by the policy as well
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Typical Terms and Conditions (2/2)
•
Insurers generally want both parties to retain some risk, though "no Seller
indemnity" policies are possible
•
Typical retention amount is 1-2% of transaction value
– Risk sharing as between Buyer and Seller for this retention amount can be subject
of negotiation, but insurers will often want the Seller to retain some of this risk.
•
Policies typically cost 3-4% of the covered amount inclusive of an
underwriting fee paid at the time underwriting commences to cover
diligence and document preparation costs
•
Spreads tightening over time
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Putting a Policy in Place (1/2)
•
Typically purchased by the Buyer (even if required by a Seller) but costs are
often shared between Buyer and Seller (via a purchase price reduction)
•
Insurance broker assists with obtaining initial quotes, underwriter selection
and process management as well as policy negotiation
•
Initial quoting
– Sell-side marketing materials (e.g., Management Presentation), audited financials
(if available) and draft transaction documents serve as the basis for quotes
– Quotes generally obtained within 3 days
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Putting a Policy in Place (2/2)
•
Underwriter diligence
– Typically lasts 3-5 days and primarily consists of review of diligence performed by
Buyer and its advisors (on a non-reliance basis)
– Diligence process culminates in an underwriter call with Buyer and its advisors to
walk through any outstanding questions/issues the underwriter may have
•
Policy negotiation and execution
– Typically signed concurrently with execution of purchase agreement to avoid no
gaps in coverage
– For transactions with delayed closings, coverage may incept at signing providing
coverage for breaches of the signing R&W discovered after signing, as well as
breaches of the closing R&W discovered after closing (but excluding breaches
that both arise and are discovered in the interim period)
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Post-Closing Claims
•
Post-closing claims submitted to the insurer but can work with broker to
assist with submission
•
Insurer behavior reflects competitive market
•
Post-closing claims submitted similar to other insurance claims
•
Initial indications from policies in recent years suggest claims and recovery
rates comparable to traditional indemnity arrangements
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R&W INSURANCE AS
TACTICAL TOOL
03
17
Tactical Value to Strategic Buyers
•
Sellers sometimes will mandate a Buyer use R&W insurance
– “no indemnity, no escrow”
•
Tool to differentiate your bid
– Improve your perceived net price without raising headline offer price
• Can be particularly useful when prices in a competitive auction expected to be similar
– Speed is life - a Buyer using R&W insurance can be ready to execute quickly
– Offer certainty of value to a seller
•
Address shorter survival periods and lower caps by insuring up to more
market levels
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Tactical Value to Strategic Buyers
•
Improve overall indemnification profile
– Opportunities to increase amount (higher cap), lengthen time period and
broaden scope, relative to what a seller would agree
•
Improve counterparty credit profile
– Replace founders or shell companies with investment grade insurance company
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Illustrative Buy-Side Implementation
Buyer Introduces First
Buyer 1
(requires
escrow /
indemnity)
Buyer 2
(requires
escrow /
indemnity)
Buyer 3
(uses R&W
Solution)
Wins
Auction
Buyer 4
(requires
escrow /
indemnity)
•
Buyer 5
(requires
escrow /
indemnity)
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Seller
• If a single buyer in an auction process is the
first, and only, potential buyer to introduce
the concept it can accomplish the following:
– Shut down the auction early as the
buyer can accept the seller’s reps as is,
knowing insurance is in place
– Arbitrage the cost of insurance against
the seller’s desire for a clean exit
– Achieve a lower up-front purchase price
in exchange for Seller obtaining a
cleaner exit
Or, if you are Buyer 1, prepare to adapt
quickly so as not to lose out to Buyer 3
Pros for Strategic Sellers
•
A tool to help facilitate a clean exit
•
Helps to get bidders to the best and final bids
– Quality of bids may not be impaired as insurance policy may result in equivalent
or better coverage than would have been a result of negotiations
•
Allows a Seller to maximize cash proceeds and minimize post-closing
indemnity risk
– Mitigates risk of protracted claims by aggressive Buyers
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Illustrative Sell-Side Implementation
Seller Introduces First
Buyer 1
Buyer 2
Seller
(introduces
no/limited
indemnity)
Buyer 3
Buyer 4
Buyer 5
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 When Seller introduces the no/limited indemnity
concept as part of an auction process to multiple
buyers, the Seller can potentially mitigate any
“discount” that a Buyer hopes to achieve by
preemptively doing so, and also ensure a
cleaner exit
 Improve comparability of bids
Hurdles to Utilization by Corporates
•
Unfamiliar terrain for lawyers and commercial teams
– Can be a change from a company's approach to making (or defending) claims
•
Counterparty risk/balance sheet issues less frequently a concern in
transactions involving only strategic parties
•
Time pressure may differ in some negotiations between strategic parties
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CONCLUSIONS AND
Q&A
04
24
What next?
•
More insurers entering a formerly limited marketplace
– Substantially more insurance capital available to facilitate using R&W Insurance in
more and larger transactions
– Process streamlined such that obtaining R&W Insurance should not slow down a
transaction, and may even help get to closing faster
•
More parties are proactively using R&W Insurance as a tool
– Not just circumstances where a PE Seller mandates it
– Strategic sellers can use to obtain a clean exit
– Buyers using proactively to differentiate a bid
•
Watch for Buyer recovery rates on claims
– Insurers touting how much they are paying out in claims - but how does that
compare with historical recovery rates for buyers making claims?
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Today's Presenters
John Ivascu
Vice President, Associate General Counsel and Assistant Corporate Secretary | Forum Energy Technologies, Inc.
John Ivascu serves as Vice President, Associate General Counsel and Assistant Corporate Secretary of Forum Energy
Technologies, a Houston, Texas based global oilfield products company, serving the drilling, subsea, completions,
production and infrastructure sectors of the oil and natural gas industry. Prior to joining Forum, Mr. Ivascu practiced
corporate finance, mergers and acquisitions, and securities law with Vinson & Elkins L.L.P. in New York and Houston. Mr.
Ivascu began his career prosecuting accounting fraud, insider trading, market manipulation, and market timing matters
for the U.S. Securities & Exchange Commission’s Division of Enforcement in New York.
Jim Marshall
Partner | Baker Botts L.L.P. | +1.713.229.1156 | [email protected]
Jim Marshall represents public and private companies, primarily in the energy sector, in a broad range of corporate and
securities matters. Mr. Marshall advises companies in connection with takeovers, including representing both bidders and
targets in connection with several high-profile contested transactions, as well as private sales and acquisitions, joint
ventures and strategic alliances, many of which involve seeking creative solutions to complex cross-border issues. He
also represents issuers and investment banking firms in connection with equity and debt capital markets transactions
and counsels companies general corporate governance matters and U.S. public company reporting requirements.
Matthew Wiener
Senior Vice President | AON Transaction Solutions | +1.713.470.9794 | [email protected]
Matthew Wiener joined the Aon Transaction Solutions Team as the head of its Southwest Region. Prior to joining the ATS
Team, Mr. Wiener was a senior associate at Vinson & Elkins LLP, where he specialized in corporate finance and securities
law matters, including mergers and acquisitions, private equity, public and private securities offerings, divestitures, and
general corporate representation. His practice included representation of a variety of public and private companies, as well
as private equity funds and investment banks, with a significant focus in the energy sector.
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