January 23rd, 2023

Special Situations M&A Insurance

By: Dean Andrews

Overview

In the first half of 2020 the M&A community expected a wave of insolvencies, with distressed restructuring advisers preparing for an extremely busy year, neither of which materialised. In fact, 2021 was the biggest year on record for M&A with $5 trillion worth of deals done globally¹.

Ultimately, the varying degrees of government support worked. A combination of furlough schemes, quantitative easing, continuation of almost zero (and in some places negative) interest rates and historically high levels of dry powder in the PE community meant listed equities reached new highs, private deals enjoyed record multiples and there was immediate rebound in employment figures. However, the stimulus had to come to an end, and with it a much anticipated correction.

2022 saw the highest inflation in 30 years¹ and dramatic increases in interest rates as a counter measure. The impact has been that equities and bond markets have lost more than $30 trillion in value in 2022, with the rise in interest rates having a significant impact on balance sheets, capital investments, M&A as well as the day to day cost of refinancing. This is now feeding through to UK insolvencies; “The number of insolvencies in Q3 2022 increased by 40% year-on-year compared to Q3 2021, as businesses weather increasingly challenging economic conditions. There were 5,595 company insolvencies in Q3 2022. Small businesses account for the overwhelming majority of these insolvencies. During 2022, there were only 104 insolvencies of businesses with turnover of more than £10m.”²
The M&A and Tax insurance market remains well placed to provide solutions to wrap around a significant variation of deal dynamics, beyond the traditional disposal process.

This article sets out further information on how M&A solutions may assist with complex, distressed dynamics.

¹https://www.ft.com/content/9188e191-4c1c-4968-a3af-9a43f086de6b

² https://www.pwc.co.uk/press-room/press-releases/pwc-comments-on-the-company-insolvency-statistics-for-q3-2022.html

Acquiring assets from an insolvency practitioner and synthetic warranties

Insolvency practitioners are not able to provide contractual recourse to a buyer when disposing of distressed assets on the basis they will know very little about the underlying business compared to a typical seller who has owned and operated it for a number of years and they do not wish to incur any personal liability.

To bridge this gap in protection, insurers can offer buyers a ‘synthetic warranty’ policy which gives the buyer effective recourse to an insurance policy in the event there is a breach of warranty.

Rather than the seller providing warranties in the share or asset purchase agreement, the warranties are ‘synthetically’ inserted into a W&I policy.

Given the dynamics of the transaction, primarily the lack of any disclosure exercise, insurers will generally offer a more limited range of warranties than they might expect to receive from a seller. Insurers will also expect to see detailed diligence carried out by the buyer. In addition to the synthetic warranties, it is also possible for the buyer to benefit from a synthetic tax indemnity. The policy would be subject to a sensible policy retention.

In the event the buyer’s diligence uncovers an identified risk, be it related to tax, potential litigation, IP or other contingent risks, other M&A insurance policies can be used to ring fence these risks and shield the buyer from potential future costs.

Sale by distressed sellers

Where sellers are in a precarious financial position, buyers may consider that they provide limited covenant strength, even if a fulsome warranty package is provided.

The use of an insurance policy in these circumstances, whether a W&I or contingent policy, provide a buyer with the comfort that they have recourse against an insurer with a strong credit rating and/or Lloyd's capacity.

Sale of an indebted asset

Where a seller is selling a heavily indebted target business, the transaction may be structured so that the majority of the consideration provided by the buyer is injected directly into the target to allow that debt to be repaid in an efficient manner.

A W&I policy can be structured so that the total amount paid by the buyer is covered by the policy, however the language needs to be tailored so that ‘Loss’ is not limited to the consideration paid for the shares which may be a fraction of the total paid.

Investing in a business

Given that many businesses will be struggling for cash flow, they may seek capital investment from new investors rather than just taking on additional debt. Again, if structured correctly, W&I policies provide the investor with recourse in the event of a breach of warranties given by the existing owners.

The key benefits of this are (i) the investors do not need to bring a claim against their co-investors which could potentially sour their working relationship and (ii) if there is a breach of warranty and the target business has failed, the investors do not need to pursue the warrantors for their personal assets.

Restructuring financing arrangements

There can be tax risks associated with restructuring financing arrangements, whether it be writing off debt or undertaking debt-for-equity swaps, that can potentially lead to a material tax charge.

Tax liability insurance can be utilised to ring fence these issues and can also cover-off any associated interest, penalties and defence costs incurred in defending a challenge by a tax authority.

Intra-group reorganisations

Organisations may look to conduct intra-group reorganisations in order to streamline supply chains, ring fence struggling businesses, liquidate certain operations or in preparation of a disposal.

The more complex an organisation’s structure and the more jurisdictions involved, the greater the chance a reorganisation creates risk. Whether it be a tax risk due to transferring assets out of a group, IP risks due to moving assets around a group or litigation risks as a result of winding up a subsidiary, contingent insurance policies are an efficient tool to ring fence these risks, providing financial certainty as to costs of the reorganisation.

Preparing for sale

Regardless of whether the sale is destressed or not, we work closely with sellers’ and corporate finance houses that assist them in integrating M&A insurance at the beginning of the disposal process.

Whether it’s inserting the terms available for a tax liability insurance policy into the data room so that bidders have comfort that there is a solution to a known tax risk, or inserting the terms available for a W&I policy in the data room which the bidders can price into their offers, initiating the M&A process early means that there is transparency between the parties and allows for an efficiently managed transaction timeline.

We are ready to work closely with you and your advisers to find the right solution for your situation.

Product	Description	Pricing Range*
W&I Insurance	Cover for financial loss incurred in relation to valid breaches of a warranty or representation pursuant to an acquisition agreement or a claim under a tax covenant or tax indemnity.	0.8% - 2.5%
Tax Liability Insurance	Cover for identified tax risks emanating from current, pending or historical transactions or reorganisations. Tax Liability Insurance can shift the responsibility for tax issues from the insured to the insurer, thereby minimising financial risks, uncertainty and associated exposures.	1% - 4%
Intellectual Property Insurance	Cover for financial losses suffered in connection with infringement lawsuits and IP invalidation proceedings, as well as to address indemnification claims related to a company’s IP or its products or services under contracts with several parties (including licensees, licensors, customers and manufacturers).	1% - 5%+
Title Insurance	Cover for a number of real estate and asset related risks. These include challenges to legal title, boundary issues, incapacity of prior owners, restrictive covenants, chancel repair liability, rights to light and missing searches.	0.1% - 1%
Liquidation Insurance	Cover to help to unlock capital held in reserves for legacy and contingent liabilities where investment funds are reaching the end of their fund lifespan or where corporate groups are looking to be rationalised.	1% - 4%
Litigation Buyout Insurance	Cover for a threatened, anticipated or current litigation, arbitration or dispute by ring-fencing the issue or providing cover in excess of the likely outcome.	5% - 10%+
Contingent Risk Insurance	Cover to offset the risks associated with identified contingent liabilities that are capable of legal and/or accounting analysis.	5% - 10%+

*Rate as a % of policy limit sought. Subject to minimum premiums. Fees and taxes in addition

About the BMS Private Equity, M&A and Tax Division

Every transaction is different and we pride ourselves on being able to structure tailored M&A insurance solutions with the broadest coverage in a clear and concise manner.

We have access to insurance capacity across the world and have developed strong relationships with M&A and Tax insurance markets in London, Europe, North America and Asia.

Our team is a group of multi-disciplined professionals with backgrounds in M&A, Insurance, Law, Tax, Finance & Accounting, and Litigation. With our global reach and experience, we have extensive expertise of cross-border and domestic M&A transactions.

We partner with our clients and their advisers to help them navigate efficiently through the course of a transaction. This entails an in depth understanding of the transaction dynamic, our client’s commercial goals and identifying potential obstacles as early as possible.

This process allows us to provide innovative insurance solutions which facilitate transactions regardless of the complexity, size and sector, all within your transaction timetable.

40

jurisdictions covered over 4 continents

85+

deals

$42bn+

transaction value

$6.7bn

largest transaction

30

dedicated professionals

BMS is a dynamic, independent, global broker established in 1980, delivering specialist insurance, reinsurance, and capital markets advisory services.

Our teams are respected globally for their specialist market knowledge, intelligent analysis, insight and understanding.

Being independent makes a key difference to our clients, giving our brokers the freedom to deliver the best solutions, tailored to meet your business needs. Coupled with our collaborative team approach, single platform worldwide and renowned personal service.

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