Insuring a Transaction – More Than Just Representations & Warranties Insurance
Insuring a Transaction – More Than Just Representations & Warranties Insurance is a contribution to CVCA Central from BFL Canada.
The number of M&A deals continue to increase at a rapid pace despite COVID-19. As these acquisitions or sales bring opportunity, it can raise complex issues that are insurable. Insurance is often an after-thought that is rushed at the close of the transaction and isn’t given due consideration earlier; it should be given consideration in the planning and due diligence process, as an avenue to help preserve the capital of both buyer and seller at the time of a transaction and going forward.
While Representations and Warranties Insurance (RWI) has been used more frequently in M&A deals to protect against losses arising from the seller’s breach of certain representations in the purchase agreement, traditional insurance policies should not be overlooked as they also provide a robust form of protection. A review and consideration of these policies should be part of the standard operating procedure incorporated into the Due Diligence process to ensure the opportunity to protect the assets of both buyer and seller are not lost.
What You Need To Know
At the time of the closing of a transaction, a change of control is triggered in most insurance policies. This can cause insurance to terminate immediately, while other insurance policies provide an automatic extended reporting period. To Avoid Pitfalls, Planning Ahead and understanding how insurance policies can be impacted is important:
- Be aware if the buyer is able to add the purchased operations to all policies, and whether the nature of operations are aligned to be added (carve out transactions may be viewed differently);
- Confirm that the insurer provides prior acts coverage to the buyer’s program, ensuring future claims will be addressed (emanating out of acts of the target prior to the acquisition date);
- Confirm whether there are contractual obligations that transfer to the purchaser that insurance fulfills;
- Question in advance of the deal close if the purchased business needs to continue with its own insurance program;
- Discuss before deal close, if seller’s policies are going into runoff, and confirm which party is responsible for paying any additional premiums, and negotiate terms in advance of the transaction;
- Be aware that the insurance market has hardened with shrinking capacity and increased costs for most lines of insurance.
Pitfalls of not considering the impact on Insurance in advance of the transaction:
- For the purchaser, if policies cancel creating a gap in coverage, future claims based on past acts may become a future liability that wasn’t accounted for, and impacts the perceived worth of the deal;
- For the seller, they may personally have obligations which insurance would have otherwise addressed, but may have an obligation to pay personally for such past matters;
- Disagreements on who is expected to pay when insurance does not respond cannot only have a financial impact but cause friction in the goodwill of the parties.
Although all insurance policies are important to consider and review, the policy most often cited is Directors and Officers (D&O) Liability. Directors & Officers Liability insurance offers protection for company directors, officers (insured persons) against claims which may arise from their decision and actions taken within the scope of their regular duties (their fiduciary duties). Often, we see requirements for D&O runoff entering into the terms of the purchase agreement, and remaining in force for 6 years from the transaction date. The D&O runoff allows claims to be reported within the 6-year window, meaning the coverage will respond only to claims made during the 6-year reporting period for acts that occurred prior to the change of control. Regardless of whether outlined in the purchase agreement, Directors & Officers Liability should be a focal point for the board of directors and the C-suite for their personal protection at the close of the deal.
Where Claims Arise (A D&O Perspective)
- Objections to the merger, with plaintiffs often announcing/alleging directors breached their fiduciary duty by agreeing to an unfair deal or failing to provide sufficient disclosures to shareholders;
- Plaintiffs suing the purchaser alleging collusion and/or aiding and abetting with the seller with respect to the deal terms;
- Oppression remedy claims – internal shareholders/employees feeling that the company (seller) should not be sold and could continue on without such sale;
- If there are employee’s jobs at risk and will be packaged out, (although some claims may be considered employment-related), claims may be for statutory obligations naming the directors and officers in the suit;
- Failure to comply with regulations or laws (including errors or misrepresentations).
Although focused on D&O insurance, there are many more lines of insurance for consideration, all of which may have nuances that require special consideration at the time of acquisition.