Liabilities that emerge after an M&A transaction closes – whether or not identified during due diligence – are unwelcome surprises to all parties involved.
These liabilities complicate the buyer’s relationship with rollover sellers and retained management, and can threaten the buyer’s ability to achieve the desired return on its investment. Attempts to manage these risks via traditional seller holdbacks or indemnity arrangements are often met by strong opposition from sellers, placing undue stress on the deal process and threatening completion of the transaction.
A Better Approach
Transaction insurance is a proven tool for managing risk in M&A transactions. It removes the need for seller holdbacks and indemnities, increases contract certainty, and allows sellers to receive more consideration at closing without requiring the buyer to forgo a source of recovery.
Your Transaction Team
NFP’s Merger & Acquisition Risk Solutions Group is a team of former M&A and tax attorneys, seasoned transaction insurance specialists, and private equity professionals that have the depth of knowledge and experience to leverage the full spectrum of transaction insurance products on behalf of NFP’s clients.
Protecting Against the Unknown
Representations & Warranties Insurance (R&W)
R&W insurance covers breaches of the representations given by the sellers and target company in an acquisition agreement. This insurance supplements, or altogether replaces, a typical seller indemnity. In an auction context, R&W insurance empowers a bidder to deliver a more attractive bid package, including increased consideration to sellers at closing. In addition, these policies have a standard coverage term that is substantially longer than a typical indemnity period, and can be structured to provide any limit of liability required by the insured, rather than a limited cap agreed to by the seller. An R&W insurance policy from a highly-rated insurance company also reduces the insured’s exposure to counterparty credit risk.
Understanding the Unknown
The Merger & Acquisition Risk Solutions Group has a deep understanding of the M&A process, acquisition agreements, and R&W insurance policy terms, which enables us to structure and negotiate a policy that interacts seamlessly with the terms of the acquisition agreement. In addition, our team carefully reviews due diligence reports and other underwriting materials to gain a detailed understanding of the substance and scope of potential coverage issues. Our hands-on approach enables us to effectively lead the effort to push back against unwarranted or overly broad exclusions and frees up the client and its counsel to focus on other aspects of the transaction.
Transaction Insurance Is Available For Many Types Of Tax And Other Known Liabilities
Meaningful exposures that are identified in the course of due diligence or that are inherent to the transaction structure often become the subject of insurmountable specific indemnity negotiations. Depending on the nature of the issues and the strength of legal defenses, coverage for these known matters can often be obtained via a standalone tax liability, contingent liability or distressed deal insurance policy.
Tax Liability Insurance
M&A and other significant corporate transactions are highly structured to achieve specific business, tax, and other objectives. Despite extensive tax planning, the reported tax treatment of these transactions is not necessarily free from doubt. Tax opinions, by their very terms, acknowledge the possibility that the intended tax treatment could be reversed by a taxing authority.
Tax insurance covers losses resulting from an insured transaction failing to qualify for its intended tax treatment. It’s often purchased where taxing authorities are unwilling to provide a private letter ruling or where the transaction timeframe doesn’t permit a ruling to be obtained. Tax policies cover additional taxes, penalties, interests, and a gross-up for taxes on insurance proceeds, in each case resulting from a failure of the insured tax position to be respected. Costs incurred to defend a challenge of the tax position are also covered.
A few examples of insurable risks include:
- Tax-free status of reorganizations under Sec. 368(a)(1) and spin-off under Sec. 355
- Tax status of S corps, REITs, and other entities
- NOL carryforwards, including limitations under Sec. 382
- Non-application of FIRPTA, transfer, withholding, or similar taxes
- Tax issues relating to executive compensation and employment arrangements
Contingent Liability and Distressed Deal Insurance
Non-tax liabilities of a target company that are disclosed or identified in due diligence present obstacles to transaction pricing and completion. These can include uninsured or underinsured wage and hour claims, securities litigation, IP disputes, product liability exposures, and so on.
- Adverse events at the target company may create legal exposure which has not yet matured into a claim or litigation, and whether that exposure will ever crystallize is uncertain.
- Alternatively, there may be existing claims or litigation at the target company, but the claims are too immature for reasonable settlement discussions, and litigation outcomes (liability and damages) are unpredictable.
- A buyer of distressed assets may face claims that seller liabilities should be imposed on them by operation of law.
Traditional methods of dealing with these risks have included upfront negotiated reductions to the purchase price and specific indemnities from sellers covering these issues.
By contrast, contingent liability insurance transfers liability in these scenarios to a third-party insurer, providing a far more efficient solution. The policy caps buyer’s financial exposure and protects against a worst-case outcome, insuring above what sellers are willing or able to indemnify. In a distressed deal context, asset buyers can utilize this insurance to protect against successor liability or fraudulent conveyance actions by unsecured or judgment creditors.
The NFP team has more than 20 years’ experience structuring tax, contingent liability, and distressed deal policies. NFP engages the most sophisticated insurers and alternative capital providers to get these difficult-to-underwrite, complex risks placed, optimizing pricing and retention structure, and negotiating the broadest coverage terms for the insured.