Millions of Reasons to Insure Mergers and Acquisitions
The COVID-19 pandemic has left its mark on economic life around the world, but most companies at that time did not give up on making large acquisitions. Data from the Institute for Mergers, Acquisitions and Alliances for Eastern Europe even confirm that the time of crisis is a good time for such decisions. The number and value of transactions concluded during the eleven months of 2020 differ from the data for the entire 2019 by only a dozen or so percent.
In the case of sale of a business or part of it, Warranties and Indemnities are usually included in the sales purchase agreement. Despite all due care, they may not be accurate. Errors in assessment, changing legal norms and interpretations, as well as incorrect wording in the SPA may cause large financial losses for the buyer and force the seller to pay compensation.
Why will M&A insurance make your transaction a success?
American private equity funds have long insured transactions. This trend has now taken root worldwide, including among medium-sized enterprises, as an alternative to trust funds and bank guarantees. According to Munich RE, in 2011-2017 the number of insurance contracts more than quadrupled, and according to the CMS European M&A Study 2019, 2018 was a record year for the M&A insurance industry. 27% of all transactions with a value of EUR 25-100 million and 37% of all major transactions were insured.
What is covered?
Thanks to M&A insurances, sellers and buyers can protect themselves against the consequences of groundless warranties contained in the SPA resulting from unknown risks. The insurance covers financial losses both in connection with the purchase of shares (share deal) and the purchase of individual assets (asset deal).
Most M&A insurances are concluded by buyers, because then they can file their claims directly to the insurance company without having to pursue them first from the seller.
Benefits for the buyer
The insurance protects the buyer’s investment, which is exposed to losses due to inaccuracies, false data, hidden defects resulting from the seller’s negligence or even willful misconduct. The due diligence process carried out by the insurer is also an additional line of defense that can help identify such risks.
The Warranties & Indemnities policy thus increases the safety of stakeholders and the chance of a successful transaction. Lawsuits become redundant, which also allows the relationship between the parties to be preserved. The insurer will take care of the entire difficult claim settlement process.
Benefits for the seller
Mergers and acquisitions insurance is particularly popular among Private Equity funds because it provides them with easier exit from an investment. In addition, it also frees them from the need to freeze cash on an escrow account or submit a bank guarantee.
The policy will protect the seller from financial consequences resulting from contractual obligations (including defence costs), but it can also boost the attractiveness of the offer – increase its price or increase the circle of interested parties. Although 95% of insurance policies are concluded by buyers, according to a CMS study, the seller, as a beneficiary of insurance cover, pays the premium in 23% of cases.
Special forms of M&A insurance
In addition to the classic W&I protection, there are many specialized solutions that can protect the buyer against the execution of risks known at the time of the transaction. They are:
- Tax Indemnity Insurance – insurance of known tax risks
- Litigation Buyout Insurance – insurance of the costs of pending litigations
- Environmental insurance – which may also cover the removal historical pollution located in the property being purchased.
In Poland, a particularly popular M&A insurance is Title Insurance, i.e. insurance against legal defects of the property purchased. Unclear or defective legal status of the real estate may give rise to claims arising from:
- violation of the spatial development plan;
- inappropriate easement;
- violation of legal restrictions;
- missing title deeds and mortgage collateral;
- breach of the rules of public procurement or tenders;
- violation of the right to light or air;
- land restitution and expropriation;
- violations of the laws of inheritance.
M&A insurance in practice
The insurer and insurance broker should be involved in the transaction process at the earliest possible stage to ensure adequate insurance coverage. The key condition for receiving an insurance offer is carrying out a professional due diligence. This is not surprising, as it is a multi-million dollar compensation liability.
A well-known example is the Danish private equity fund FSN Capital Partners, who received the payment of the full sum insured – EUR 50 million. FSN Capital filed a claim in June 2018, shortly after acquiring Gram Equipment earlier in the same year, claiming that the seller repeatedly breached several warranties in the SPA, including warranties regarding a loyal obligation of disclosure of information and accounting documentation by the seller by providing false information and misleading information in the sales process. As a result of the extensive legal research, a consortium of insurers has recognized its liability under the policy and granted the payment of the full limit.
Claims like this consistently are filed to the insurers offering these risks. Interestingly, most notifications of circumstances (over 30%) concern policies concluded for smaller transactions – up to USD 100 million. In the case of transactions worth over USD 250 million, the notification percentage is only a dozen or so percent. Most of the notifications are filed within 18 months from the date of concluding the policy. Therefore, these data confirm that this is not only a hypothetical risk, and the policy is therefore a real protection of the interests of the seller and the buyer.
Financial Lines Practice Leader,
Insurance and Reinsurance Broker, GrECo Polska
Last Updated on December 18, 2020 by Karolina Ampulska