This article will explore the most common forms of M&A insurance available today; the process and timelines of procuring M&A insurance; and some of the benefits. Generally speaking, there are three particular forms of M&A insurance: (i) Representation & Warranties (R&W), (ii) Tax Liability, and (iii) Contingent Liability Insurance. Among the three, R&W Insurance is the most popular and widely available insurance coverage for M&A transactions followed by Tax Liability and Contingent Liability Insurance.[i] The accelerating prevalence of M&A insurance and the broadening scope of policy coverage would require parties to have legal counsel who understand the intricacies in which policy coverage and purchase agreements intersect.
Representation and Warranties Insurance
R&W insurance protects the insured from unknown and unforeseen seller breaches of representations and warranties in the purchase agreement. Although both buyers and sellers can purchase R&W Insurance, the buyer is normally the party who elects to purchase this kind of coverage. In a buyer policy, the insurer will directly pay the buyer for the seller’s breach of representations and warranties; and it will typically cover seller’s fraud. Conversely, in a seller policy, the buyer will first have to pursue a claim against the seller to trigger R&W coverage with fraud not being covered.
The benefits of R&W Insurance
A buyer may benefit from R&W insurance for the following reasons:
- Enhances protection in the event of post-closing damages are suffered, either supplementing or replacing the traditional Seller’s indemnity;
- Provides coverage for losses in an amount greater than what a Seller may otherwise agree to indemnify;
- Extends coverage beyond the survival limitations of the R&Ws in the agreement, giving the Buyer a longer time to discover deficiencies and unknown risks;
- Relieves concerns about collecting from a Seller who may have a poor financial situation;
- Induces the Seller into making more extensive and more industry-standardized R&Ws which will increase the Buyer’s likelihood of successfully making an insurance claim; and
- Reduces friction amongst participants during the negotiation process and preserves relationships with Sellers who may continue as employees or consultants to the company
A seller may benefit from R&W insurance for the following reasons:
- Reduces the need and degree of the Seller’s indemnities and escrow holdbacks and, overall, provides the Seller with a cleaner exit with fewer contingent liabilities;
- Potentially increases the purchase price and reduces the likelihood of the re-negotiation of economic terms during the due diligence phase;
- Protects minority or passive investors of the Seller who have joint and several liability to indemnify the Buyer and mitigates the impact of issues raised by minority shareholders; and
- Provides comfort for individual or family-run companies who desire cleaner exits.
Costs and coverage
To receive a preliminary quote, the insurance broker will need some of the relevant documents on the transaction including a draft of the purchase agreement and the parties’ financials. The broker will then create a submission package and seek quotes from the market who the broker will then present to the client. If the client decides to proceed further, they will choose an insurer and pay an underwriting fee typically ranging from $30,000 to $50,000 to cover the insurer’s own due diligence. The entire underwriting process can take several days depending on the size and nature of the transaction.[ii]
R&W Insurance will typically cover losses of up to 10% of the transaction deal value. For instance, a $200 million deal will likely have a $20 million coverage cap. The premium will generally be a percentage of the policy limit; the current percentage at this time ranges between 2% and 3%. Thus, using the same $200 transaction with a $20 million cap, the premium will range between $400,000 to $600,000. Furthermore, most policies will contain a retention amount, similar to a deductible or basket threshold. The latter is usually 1% of the transaction. In recent years, insurers have been including a provision that ends the retention after the first year of the transaction closing.[iii]
Tax Liability Insurance
Tax Liability Insurance transfers a known tax contingency, normally uncovered during the due diligence process, or an uncertain tax position from the insured to the insurer. The purpose of Tax Liability Insurance is to help reduce or eliminate financial losses resulting from a tax authority's successful challenge (a known-unknown) or protect you from an identified tax issue for which an advanced ruling from the relevant authorities could not be obtained (a known-known).
The seller may purchase Tax Liability insurance for a known premium rather than leaving funds from the transaction in escrow for possible tax authorities challenges and post-closing rulings. A buyer in an M&A transaction may also purchase Tax Liability Insurance to protect themselves from potential tax risks. Tax Liability Insurance addresses specific tax concerns that could possibly stall or halt the transaction altogether.
Tax Liability Insurance can cover exposure both at the domestic level (federal, provincial, and local) and at the international level. Tax Liability Insurance covers you from financial losses resulting from additional taxes, non-criminal fines, and penalties. Tax Liability policies often cover legal and financial advice to resolve claims with the Canada Revenue Agency and other relevant taxing authorities.
Contingent Liability Insurance
Contingent Liability Insurance covers a known or uncertain exposure to litigation that neither party in the transaction is willing to financially cover. Contingent Liability Insurance can be used for a broad range of claims including, environmental, exposures, employment claims, contractual disputes, shareholder disputes, product liability and more.[iv]
Contingent Liability Insurance coverages and premiums will heavily focus on a fact-specific analysis of the possible or known litigation risk. Contingent liability coverages and premiums will significantly vary depending on the level of the legal threat and the insured’s likely outcome. Similarly, the cost and overall timing of the underwriting process will depend on multiple factors including having to hire outside counsel or expert evidence.[v]
Is M&A Insurance Right for You
The aforementioned types of M&A insurance provide the insured with significant benefits, which explains why they are used as a strategy across M&A broadly. M&A insurance is not necessarily more beneficial for any specific transaction value range. Ultimately, whether M&A insurance is advisable will depend on the specifics of the transaction and the needs of the parties. To discuss your M&A transaction and advisory services needs, whether you are a prospective buyer or seller, please contact Vincent Ho or any member of our M&A and Private Equity group.
[i] Ingrid Sapona, “Mergers & Acquisition Insurance – Part II”, Insurance Institute, online: < https://www.insuranceinstitute.ca/en/cipsociety/information-services/advantage-monthly/0419-mergers-and-acquisitions-partii >
[iii] Ingrid Sapona, “Mergers & Acquisition Insurance – Part I”, Insurance Institute, online: < https://www.insuranceinstitute.ca/en/cipsociety/information-services/advantage-monthly/0119-mergers-and-acquisitions-insurance>