M&A Risk Managem ent:
warranties, indemnities and insurance
protections
Friday 21 April 2017
Warranties: The Basics
Richard Wise – Partner, Addleshaw Goddard LLP
Warranties and Indemnities
▶ Contractual protections for the benefit of a buyer
▶ Included in a share or asset purchase agreement
▶ Warranties
▶ Statements by the seller about a particular state of affairs of the target or business
▶ Breach: claim in damages for reduction in the value of the target or business
▶ Indemnities
▶ Promise to reimburse in respect of a particular liability
▶ Duty to mitigate?
Warranties
▶ Only as valuable as the warrantor(s)
▶ Limitations
▶ Awareness qualifications
▶ Disclosure
▶ Time limits
▶ Financial limits
▶ Split exchange and completion
▶ Repeating warranties
▶ ‘Lockbox’ mechanism
Key Themes and Trends of Warranty Claims
Richard Wise – Partner, Addleshaw Goddard LLP
Who makes warranty claims?
▶ Corporate buyers more prevalent claimants
▶ Post deal teams to maximise return
▶ Cultural differences
▶ Previous recoveries can encourage claims
▶ Sending a message to the market
(dishonesty/insufficient disclosure)
Comparative size of warranty claims by claimant
Which warranties give rise to claims?
Categories of breach
Limitations on claims – Liability cap
Limitations on claims – Other matters
▶ Notification periods not generally an issue
assuming appropriate monitoring of the
position by the buyer (1 - 2 years for nontax warranties)
▶ Basket/de minimis provisions not
challenged
▶ Time limits for bringing a claim following
notification should also be considered allow at least a year to explore issues and
negotiate?
▶ Escrow amounts often inadequate for
warranty claim values
Warranty claims – worthwhile?
▶ Well drafted warranties will help flush out issues pre-completion
▶ The majority of cases settled, with only 20% proceeding all the way to trial
▶ All buyer claims we reviewed resulted in a pay-out, save for one which settled on a drop
hands basis
▶ Suggests buyers can achieve positive financial recovery
Warranty & Indemnity Insurance: Structure,
Process and Use
Anka Taylor – Director, Aon
Aon Risk Solutions | Speciality | Financial Services Group
Copyright Aon UK Limited. All rights reserved.
Aon UK Limited is authorised and regulated by the Financial Conduct Authority.
13
Transaction Liability Product Overview
Traditional
Improve deal execution
around unknown issues
Improve execution
around specific deal
issues
•
•
Indemnifications and/or escrows within
the SPA
Most common of these issues are tax
issues, which have been are usually
addressed with a purchase price
adjustments and/or tax opinion
TL Solution
Warranty & Indemnity (W&I)
Allows cleaner exits, better
IRR, streamlined negotiations
Tax Insurance
Relevant Trends
•
•
•
•
•
Stable pricing with cover and capacity
continuing to grow
U.S. capacity per deal ~$500 million
European/UK per deal ~ €600-€700m
(depending on sector, jurisdiction etc)
The market has significantly expanded
capacity in this space (~$700 million for a
given deal)
Pricing remains relatively steady at 3-6%
depending on exposure
▶
The product is available worldwide, with highest market penetration in the USA, UK and Australia.
Fast growing regions include Asia, South Africa and the Middle East.
▶
Policies are underwritten under a variety of governing laws (most common in EMEA UK, Dutch and
German law).
▶
Policy durations differ between different warranty types, maximum period generally seven years.
Aon Strategic Advisors and Transaction Solutions
Proprietary & Confidential
Warranty & Indemnity – Why used?
Risk Transfer
•
Where sellers wish to protect their balance sheet against SPA claims.
•
Shareholders who are looking to retire or who are trustees.
•
Where buyers have concerns on recoverability of losses from sellers.
Strategic
Traditional Deal Security Measures
• Escrow, earn-outs or deferred
consideration
- Ineffective use of capital
- Delays return of capital to
investors or shareholders
- Risk of future litigation
- Delays valuation
• Bank guarantees
- Relatively expensive
• Third-party guarantee/indemnity
- May not provide sufficient buyer
comfort
• Charge or mortgage over seller’s
assets
- May not provide sufficient buyer
comfort
- Not practicable if seller returning
capital to shareholders or investors
• Price chipping
- Unattractive for sellers and does
not quantify risks for buyers
•
Buyers using it in auctions as a tool to differentiate a bid.
•
Where buyers wish to protect future business relationships.
•
W&I policies where real estate deals via share sales becoming almost standard
Deal issues
•
Where the financial cap offered is for an insufficient amount or insufficient period
•
Increasing scope of the deal warranties e.g. management warranty deeds.
Aon Strategic Advisors and Transaction Solutions
Proprietary & Confidential
Warranty & Indemnity – how it works
W&I insurance protects an insured party from losses resulting from breaches in warranties given by
sellers or from claims under indemnities
▶
Covers losses arising out of an unexpected or unforeseen breach of general or specific warranties or
claims under a tax indemnity
▶
W&I policies can be taken out by the buyer or the seller
▶
The policy attracts a ‘one time’ premium at inception
▶
Covers unknown matters only
▶
Bespoke terms tailored to each transaction
▶
Cover of indemnities depends largely on the specific case
▶
Insurers expect a balanced warranty package, appropriate due diligence and a comprehensive
disclosure process
Proprietary and confidential
16
Warranty & Indemnity – Buyer Example
Situation:
The buyer(s) is the insured.
Requesting coverage against financial loss suffered as a result of a breach of the seller’s
warranties.
Sale & Purchase Agreement
Transaction value
Solution:
Warrantors give warranties but these are capped at a lower amount, the insurance policy
sits in excess of this.
Policy is independent of the seller, therefore the buyer is entitled to make a claim directly
against the policy
Policy limit (buyer’s risk
appetite to determine limit)
Buyer’s
risk
Policy to protect against
financial loss
Limitation of liability for
breach of warranty
under the SPA
Seller’s
risk
Aon Strategic Advisors and Transaction Solutions
Proprietary & Confidential
Insurance
policy
Warranty & Indemnity Insurance Policy Terms
Coverage Basics
▶ Broadest cover for warranties that are:
▶
▶
Fairly balanced and in sellers’ scope of knowledge
▶
Capable of factual verification
▶
Not forward looking
Typical transactions: Private transactions with a purchase
price of £10 million to £2-3 billion
▶
Pricing: typically 1% - 2.5% for most EMEA deals
▶
Retentions: 1-3% of transaction value; minimum retention
usually 0.75%. Tipping to nil if real estate.
▶
De minimis: 0.01% of transaction value generally
▶
Policy period: Mirrors or extends underlying agreement,
up to 7 years
Proprietary and confidential
Excluded Matters
Common exclusions:
• Matters known to either party at completion
• Fraud of the insured party
• Consequential losses
• Forecasts/forward-looking warranties
• Contamination/pollution
• Inadequacy of business insurance cover
• Fines and penalties uninsurable at law
• Pension underfunding, transfer pricing and
secondary tax
• Post-closing price adjustments/leakage indemnities
• Bribery or corruption
Transaction-Specific Exclusions:
• Known or high-risk environmental issues
• Disclosed or known issues that are typically subject
to a specific indemnity
Transaction Liability Overview - Market and Players
▶ Increased popularity: Estimate 1000+ policies underwritten in the US, Asia Pac EMEA (the
majority in the UK, Nordics and Germany) in 2016 industry wide.
▶ Insurance market well-developed (mix of company, Lloyd’s syndicates and MGU)
▶ Insurance companies and Aon are staffed by former M&A lawyers who work on deal timeframes
▶ Policies are customised and underwriting process streamlined
▶ New market entrants during 2016 – Chubb
▶ Reinsurance is provided by several well known markets – Swiss Re, Partner Re, Munich Re,
Hanover Re as well as some other smaller markets
Aon Strategic Advisors and Transaction Solutions
Proprietary & Confidential
Warranty & Indemnity – Underwriting Considerations
▶ Sector of target
▶ Geographical spread of target operations
▶ Domicile of insured
▶ Governing law of SPA and policy
▶ Transaction value
▶ Insurance limit sought
▶ Quality and scope of DD - whether seller or buyer
▶ Robust negotiations and full disclosure exercise
▶ Scope and breadth of warranties
▶ Indications of endemic issues within target
These are all fundamental u/w considerations and then secondly will go to pricing
Warranty & Indemnity Insurance:
Claims
Richard Wise – Partner, Addleshaw Goddard LLP
Claims experience
▶ Relatively limited data
▶ Growth market:
▶ Howden reported 55% more policies in 2015 than 2014
▶ Marsh reported 32% more policies in 2015 than 2014
▶ Notifications
▶ AIG report 1 in 7 policies globally give rise to a notification
▶ Lockton estimate 13-16% of policies give rise to a notification
Alleged Breaches – AIG’s Claims Data (2011 - 2014)
▶ Financial statements: 28%
▶ Employee: 8%
▶ Tax: 13%
▶ Litigation: 8%
▶ Contracts: 11%
▶ Compliance 5%
▶ IP: 10%
▶ All other: 17%
▶ Reflects pattern seen in underlying / uninsured warranty claims data
▶ Accounting / financial warranties
▶ Source: What Happens After the Deal Closes? AIG (2017)
Timing – AIG’s Claims Data (2011 - 2014)
▶ 0 – 6 months: 25% of notifications
▶ 6 – 12 months: 27% of notifications
▶ 12 – 18 months: 22% of notifications
▶ 74% of notifications within first 18 months post-close
▶ Reflects pattern seen in underlying / uninsured warranty claims data
▶ 2 years / audits
▶ Source: What Happens After the Deal Closes? AIG (2017)
Deal Size – AIG’s Claims Data (2011 - 2014)
▶ Does this reflect a well considered and funded DD process in mid-market?
▶ Source: What Happens After the Deal Closes? AIG (2017)
Warranty & Indemnity Insurance: Innovations
Anka Taylor – Director, Aon
Aon Risk Solutions | Speciality | Financial Services Group
Copyright Aon UK Limited. All rights reserved.
Aon UK Limited is authorised and regulated by the Financial Conduct Authority.
26
Warranty & Indemnity – Innovations
Innovation in coverage
▶ Scope of the warranties can be extended beyond the terms in the SPA - removal of awareness
qualifiers
▶ Policy can increase the caps on liability beyond those in the SPA – both financial and time
limitations
▶ US style coverage available where underlying SPA incorporates US features including
materiality scrapes, more limited disclosure regime, measure of loss on indemnity basis
▶ Benefit of the policy can be assigned to finance parties
▶ Synthetic tax coverage
Innovation in usage
▶ Increasing use of W&I product by sellers in auctions
▶ Rise of repeat institutional buyers – able to leverage market to get better pricing or coverage
Warranty & Indemnity Insurance:
The future?
Richard Wise and Anka Taylor
The future?
▶ The quality of the due diligence and its interaction with the underwriting process
▶ Exclusions and the value of the insurance product
▶ The role of the sell side flip
▶ Claims
addleshawgoddard.com
Doha, Dubai, Hong Kong, Leeds, London, Manchester, Muscat, Singapore and Tokyo*
* a formal alliance with Hashidate Law Office