M & A 2015M I N N E A P O L I S ▼ N O V E M B E R 1 8CONFERENCE
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Representation and Warranty Insurance: Updates on This Important and Rapidly Changing Industry
Linda Crow, Faegre Baker DanielsJay Rittberg, AIGCraig Schioppo, Marsh USA Inc.Moderator: Kate Sherburne, Faegre Baker Daniels
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Overview
Protects against unknown and unforeseen losses arising from a breach of the representations and warranties in a purchase agreement.
Why it is used:►Remove or reduce escrow or holdback in the transaction;
extend survival periods►Provide recourse when no seller indemnity possible►Distinguish bid in competitive auction►Protect key relationships or passive investors►Distribute sale proceeds faster
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Types of R&W Insurance Policies
►Buyer-Side Policy (85+% of policies issued)► Insurance replaces sellers’ potential indemnification liabilities► Can enhance indemnification terms
► Extended survival periods, increased cap, materiality scrape► Covers fraud by sellers► Limited subrogation rights against sellers and management team
►Seller-Side Policy► Sellers backstop their potential indemnification liabilities► Mirrors indemnification terms in agreement► Typically excludes fraud of sellers► Knowledge between sponsors and management sellers can be severed
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Insurance Market Evolution
►Broader coverage and better alignment with underlying agreement►Speed of execution – more streamlined underwriting process►Significantly increased limits of liability available►Material reduction in premium rates and deductible levels – enhanced
competition►Greater market awareness►Claims experience
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How You’ll Encounter It
►Private equity has been the early adopter
►Strategic encountering as a Seller-imposed requirement in an auction
►Middle market M&A emphasis and application, but growing in upper middle markets
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Market Growth
►Already an established product in certain markets, has seen significant growth in North America over past 5 years:
►AIG expects approximately 2,000 submissions and 300 policies in 2015
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215 335525
1150
0
500
1000
1500
2011 2012 2013 2014
Number of Submissions
35 59 95
230
0
200
400
2011 2012 2013 2014
Number of Policies Bound
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Pricing
► Diligence Fee: generally $20K - $40K depending on nature of deal► Premiums
► Typically 3.5% – 4% of limit insurance (lower outside of U.S.; higher for smaller policies)► Either party can pay
► Deductibles► Typically 1% - 2% of transaction value (no indemnity deals may be higher)► Buyer-side policies often use escrow account as deductible► Seller-side policies use a negotiated amount► Drop-downs available and erosions available for loss outside coverage
► Limits► Up to $500M of limits available in global market► Hard to insure a deal with a limit lower than $5M► Can be used effectively in transactions from $25M - $3B+
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The Broker
►How to choose a Broker
►What the Broker should do for you
►What information the Broker needs to obtain quotes
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The Insurer
► Preliminary information submitted to insurer:► Acquisition agreement, financial information, offering memo
► Underwriting considerations:► Identity of the buyer, seller and their advisors► Sector of target business and location► Quality of the transaction process► Quality of due diligence/disclosures► Value of transaction► Scope of the warranties – buyer or seller friendly?► Seller’s liability under the agreement► Gap between signing and completion?► Why do they want insurance?► Do both parties know about the insurance?
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The Process
►Give yourself at least 2 weeks to be comfortable (can be done faster, if needed)► Engage Broker► Broker delivers quotes; Negotiate NBIL (2-4 days)► Diligence; pay underwriting fee (5-10 days)
► High level review of due diligence process (if buyer-side) or disclosure process (if seller-side)
► Access to legal, financial, tax, other DD reports (if buyer-side)► Conference call(s) with deal team
► Negotiate policy (a few days, runs concurrent with end of diligence period)►Works on a parallel track to purchase agreement►Can incept at signing or closing
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The Policy
►Conform coverage to your purchase agreement
►Common Exclusions► Known issues identified in disclosure schedules and environmental reports► Asbestos claims► Losses covered in purchase price adjustments► Issue known to a member of the insured’s deal team► Breaches of covenants► Claims for non-monetary relief► Criminal fines or penalties► Fraud of seller (if a sell-side policy)
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The Policy (Cont.)
►Exclusions that may arise depending on industry/facts:► Product liability claims► Underfunded benefit plans► Healthcare billing practices► California wage and hour law issues► Big pharma issues► FCPA
►Can expand coverage from purchase agreement:► Materiality scrapes► Survival periods► Consequential and multiple damages
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The Purchase Agreement
►Could be silent
►Might be “fully baked” (covenants, closing conditions, etc.)
► Indemnification provisions might reference as a first recourse
►May specify that escrow is only available for claims not covered by insurance
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Claims Experience
► Industry-wide, claims payments have ranged from $500K - $25M ► Insurers have dedicated claims professionals and law firm relationships
to offer claims solutions►Brokers and independent advisors serve as advocates for insureds►Examples of claims:
► Financial Statements: Recently paid $25M for a financial statements-related claim
► Accounts Receivable: Seller-side policy responds to claim brought by buyer for breach of financial statement R&Ws related to target’s issuance of over $1M of unrecorded gift certificates
► Patent Infringement: Seller-side policy responds to third-party patent infringement claim
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Frequently Made Claims
►Financial statements, compliance with laws, taxes, and undisclosed liabilities are the most frequently alleged breaches.
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0%
5%
10%
15%
20%
Type of w arranty breach
Financials;AR;Inv. -18% Comp. With Laws/Lit. -17% Tax -14%No. Undisc. Liab. -10% IP -8% Contracts -5%Full Disc. -4% Emp. Ben. -4% Real Prop. -3%Other -16%
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Timing of Claims
►More than half of all claims notices are received within the first 12 months of the policy’s issuance.
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