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Transactional insurance solutions for distressed M&A

Navigating Deal Risk in a COVID-19 Landscape

Mergers and Acquisitions
COVID 19 Coronavirus|Mergers and Acquisitions

July 30, 2020

As businesses and investors tackle challenges caused by the COVID-19 pandemic, many will undoubtedly need to restructure businesses and shore up capital and liquidity. Transactional insurance can play a key role.

As businesses and investors tackle the multitude of challenges that the current COVID-19 pandemic is causing to the economy, many will undoubtedly need to restructure businesses and shore up the capital and liquidity to meet both immediate requirements and return to strong performance on the other side of this crisis. The effective utilization of transactional risk insurance can play a key role in serving these needs by providing investors and companies with an alternative to traditional risk allocation strategies.

Representations and warranties insurance

Representations and Warranties Insurance (RWI) has seen a tremendous rise in utilization during the past several years – so much so that it has become a standard feature in private M&A transactions. Most of this uptick has occurred in the context of a booming M&A cycle. Given the dramatic economic slowdown in the US and global markets due to the COVID-19 crisis, dealmakers may be looking for new opportunities to acquire or divest distressed assets or businesses.

Out-of-court sales

For distressed acquisitions outside of the bankruptcy process, RWI is available in the same way that it has traditionally been used. Given that there are suddenly fewer deals in the market, insurers are increasingly willing to offer coverage for distressed deals, particularly for transactions covering target companies that were financially healthy before the COVID-19 crisis. RWI can offer coverage for unknown breaches of representations and warranties and thus provide buyers with recourse for breaches of representations in circumstances in which the seller is unwilling or unable to provide indemnification. As in any transaction where RWI is being deployed, RWI insurers will need to get comfortable that fulsome diligence has been performed by the buyer and that the sellers and/or target company are providing appropriate levels of access and disclosure to facilitate the buyer’s due diligence. RWI can also be used to mitigate credit risk in situations in which the buyer has concerns about a seller’s ability to stand behind its indemnity obligations.

363 Sales

RWI has not frequently been used in the context of a formal bankruptcy (a 363 sale, named for the relevant section of Chapter 11 of the Bankruptcy Code), principally because RWI gained traction during a period of substantial economic growth. However, RWI can offer significant benefits in the context of a 363 sale.

For both private equity firms and strategic purchasers, a potential new wave of Section 363 auctions can present significant opportunities to purchase businesses at discounted prices. Section 363 sales also offer buyers protections that are generally not available outside of the bankruptcy context. The “free and clear” order given by a court in a 363 sale extinguishes substantial third-party claims and liens risk; however, buyers may still bear the risk of first-party claims due to a breach of the seller’s representations. Because a 363 sale does not provide recourse for first-party claims, RWI can provide the buyer with protection for unknown liabilities, including for customer and supplier issues, compliance issues, product liability, intellectual property or environmental liabilities. With the help of such protection, buyers may obtain comfort and risk may be mitigated such that they are willing to pay a higher price for distressed assets, which would also benefit creditors in the bankruptcy.

Minority investments

We also expect that the number of investors seeking to acquire a minority stake in a distressed business will increase during and after the crisis. Because the use of RWI in minority investments was on the rise pre-COVID-19, it is likely that RWI will continue to be a heavily utilized tool for minority acquisitions going forward. RWI can benefit minority stakeholders in the same ways that the insurance benefits majority acquirors, namely by giving recourse to the investor for its pro rata share of company level loss, or 100% of investor loss, resulting from the breach of a representation and warranty.

Tax insurance

Additionally, debtors and investors may encounter unique tax issues as they seek to modify loans or acquire distressed businesses. A separate tax insurance policy can protect the debtor and/or the buyer from unexpected tax liabilities that may arise from a debt restructuring and a distressed business acquisition. For example, buyers may be motivated by the ability to use the target company’s net operating losses (NOLs), the availability of which can be uncertain. If RWI insurers cannot agree to cover NOLs, tax insurance may be available to cover such risks.

Contingent liability insurance

Unlike RWI, which covers only unknown exposures, contingent liability insurance can be used to limit or eliminate the parties’ exposure to identified risks, enabling the transaction to proceed to closing without the parties having to take on undue risk, or encounter slowdowns and purchase price impairment. In the context of a distressed target, this could include exploring protection around successor liability, litigation or fraudulent conveyance risks.

Successor liability insurance

Outside of a 363 sale, buyers of distressed assets or businesses may be held liable for events that occurred prior to the acquisition. In such situations, there may not be recourse available and the buyers may be left with responsibility for issues such as service to the target company’s customers, service for products that are still under warranty or product liability for products that were sold prior to the acquisition. Successor liability insurance can offer buyers protection in cases where claims have not yet been made for injury or damage that occurred prior to the acquisition. 

Litigation buyout insurance

With creditor deadlines and threatened potential bankruptcy, many distressed transactions are forced to occur under tight timeframes, without the ability of the buyers to wait to resolve pending litigation prior to concluding the transaction. Litigation buyout insurance can help limit the exposure by capping the total amount of liability.

Fraudulent conveyance

In situations where the parties are concerned that the transaction will be deemed a “fraudulent transfer” and invalidated in a bankruptcy proceeding, a fraudulent transfer policy may be available to cover the risk.

Conclusion

It is our expectation that transactional risk insurers will continue to compete for opportunities and new ways to adapt to the changing M&A environment. We expect greater flexibility and innovation in transactional insurance as underwriters strive to meet the needs and challenges that investors and companies face. Using insurance to tackle these complex issues is achievable through the coordination of sophisticated brokerage firms and underwriters. Willis Towers Watson’s experienced team of dedicated transaction insurance professionals placed over 440 transactional insurance policies in North America in 2019 alone with total limits in excess of $7.5 billion and is committed to continuing to find transactional insurance solutions to facilitate this new and changing M&A market.

Disclaimer

Willis Towers Watson hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, Willis Towers Watson offers insurance products through licensed subsidiaries of Willis North America Inc., including Willis Towers Watson Northeast Inc. (in the United States) and Willis Canada, Inc.

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Contacts

Bill Monat
Senior Director, Transactional Risk Leader

Julia Papastavridis
Director

Mergers & Acquisitions Group


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