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Mergers and acquisitions insurance policies offer insurance protection for the liability risks of corporate transactions, either through warranty and indemnity (W&I) insurance to secure the guarantees given by the seller in the purchase agreement, or a fiscal responsibility insurance to guarantee the fiscal risks already identified, or a combination of both. In 2021, the once-niche product finally became an integral part of the M&A toolkit.
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However, last year was not only characterized by a particularly high demand for W&I insurance. Rather, the trend of recent years, fueled by the strong seller’s market, continued that more and more synthetic cover modules are making their way into W&I policies, such as
- policy terms that are entirely separate from the limitation periods under the purchase contract,
- Completely separate definitions, for example, for the concept of damage or the definitions of “Fair Disclosure” or “Know Seller”, which no longer have to reflect the wording of the purchase contract as before, until
- complete synthetic warranty catalogs (only included in the insurance policy and no longer in the purchase contract).
The strong seller’s market tempts many sellers to waive warranties in their draft contracts altogether and refer prospective buyers exclusively to the insurer. Especially in auction processes, potential buyers seldom have the courage to demand risk coverage through (previously standard) seller guarantees. This often means that buyers have to put up with insufficient (insurance) protection or, towards the end of the sales process, enter into long and difficult negotiations with the seller about an appropriate distribution of risk and, ultimately, about a ( though limited) The seller’s liability for breach of warranty must occur, as synthetic coverage could not be regularly obtained from the insurance market when requested, usually at short notice.
Synthetic coverage – a definition
As in the classic W&I insurance, there are two contracts with different contracting parties for the insurance with synthetic insurance coverage: On the one hand, the contract of sale of the company negotiated between the buyer and the seller with a broad exclusion of liability and normally without a catalog of guarantees, and on the other hand, the contract negotiated between the buyer (as policyholder) and the insurer Insurance contract with synthetic insurance coverage, in which the insurer undertakes to assume the economic risks of the buyer if certain synthetic guarantees agreed in the insurance contract between the buyer and the insurer turn out to be false or certain risks materialize, from which it is intended to exempt.
Unlike conventional W&I insurance, synthetic policies therefore do not contain a reference to a warranty catalog contained in the purchase contract and agreed between the buyer and seller, nor to other definitions in the purchase contract required to determine liability. All this can only be found in the insurance contract concluded between the buyer and the insurer. Therefore, synthetic insurance coverage should not be understood as a rigid product of the W&I insurer, but rather as the result of negotiations between the insurer and the buyer regarding the guarantees covered by the insurance policy.
By waiving the guarantees provided by the seller, insurers give up their last safety net, the ability to bring recourse against the seller in the event of fraud, bad faith or unexpected guarantees. In addition, insurers are naturally skeptical when a seller is unwilling to guarantee the accuracy of his statements in the purchase contract, even though he could reduce his liability risk to virtually zero with conventional W&I insurance. In this context, it is not surprising that insurers have (until now) been quite cautious on the subject of synthetic insurance policies and generally only offer them in cases that seem “calculable” to them.
Examples of synthetic policies
Some insurers have launched their own synthetic policy for real estate transactions, which includes a standard catalog of guarantees (including examination instructions for buyer due diligence teams). This development is logical, as many insurers regard real estate transactions as comparatively easy-to-assess risk transactions, especially since many steps here are already standardized or can be checked very thoroughly without the help of the seller, which offers the insurer the necessary convenience. .
Regardless of the industry branch of the transaction, insurers will also embark on the adventure of a “synthetic insurance policy” if the broker can clearly explain why the seller cannot provide any collateral in this transaction or why a catalog of guarantees between the buyer. and the insurance broker is the best way in the specific situation. A classic example is the sale by the insolvency administrator, who will not normally be able to provide valuable collateral (at least in the typical case of an asset deal), and also has a greater interest in providing collateral for personal liability risks. give up completely. In addition, there is a lack of knowledge about the target company and often poor access to information. But other constellations are also conceivable, where the seller cannot give any guarantee or where a different approach seems to be a more sensible option. As mentioned, there is even a tendency in the market to try to achieve synthetic coverage through W&I insurance in “classic” M&A operations. In any case, this requires good and timely preparation and execution of the transaction.
On the one hand, it depends on the broker’s market knowledge, which has to check individually for each transaction which insurers are suitable for the desired synthetic insurance or can be persuaded to offer it, because not all W&I insurers have the same experience and will. to go this way. On the other hand, it is particularly important in these cases that the broker succeeds in convincing the insurer of the seller’s honesty and that he convincingly explains the reasons for his refusal to provide guarantees. In addition, these cases require particularly detailed and extensive due diligence coordinated with the insurer by the buyer’s advisors, based on a detailed disclosure process. This must be well prepared on the part of the prospective buyer, but it must also be made possible by the seller providing the appropriate information.
Occasionally, there may be cases where the W&I insurer is not satisfied with the information available or has questions about the explanation of why the seller cannot provide guarantees in the transaction documents.
“Management Warranty Deed” as a solution?
In these cases, it may be necessary to present the so-called Management Guarantee Deed (also Management Guarantee Declaration) to make the synthetic guarantee solution possible. It is simply a catalog of guarantees negotiated between the management of the target company and the buyer, on which the insurer W&I finally provides insurance coverage. Experience shows that considerable effort is sometimes required (if possible) to get the administration to formulate such a catalog of guarantees or to participate in the formulation. The main reason for this is probably concern about personal responsibility. If you wish to persuade management to make such a statement, it may be necessary to issue a corresponding exemption statement or otherwise incentivize management. In particular, because prospective buyers often want, and sometimes depend on, management to stay on board after the acquisition, the options here are limited.
In short, it can be said that it does not seem impossible to conclude a catalog of synthetic guarantees with a W&I insurer even for “typical” M&A transactions. However, it requires good and timely preparation, in-depth knowledge of the market and a well-established team of advisors who know and understand the requirements of W&I insurers and also in the context of the transaction process, be it due diligence, either in the preparation and negotiation of transaction documents. The willingness of W&I insurance solution providers to insure synthetic collateral catalogs remains a key issue. After many were able to “pick up the raisins” from trades offered at the end of 2021 and synthetic coverage requests often fell by the wayside, there should be more willingness to deal with them again in the future.