February 18th, 2022

Private Equity, M&A and Tax

Special Situations M&A Insurance

By: Dean Andrews

Overview

In the first half of 2020 the M&A community expected a wave of insolvencies, with distressed restructuring advisers preparing for an extremely busy year, neither of which materialised. In fact, 2021 was the biggest year on record for M&A with $5 trillion worth of deals done globally1. Ultimately, the varying degrees of government support worked. A combination of furlough schemes, quantitative easing, continuation of almost zero (and in some places negative) interest rates and historically high levels of dry powder in the PE community meant listed equities reached new highs, private deals enjoyed record multiples and there was a very quick rebound in employment figures. However, the stimulus had to come to an end, and with it a much anticipated correction.

In the last quarter of 2021 furlough schemes tapered or ended. As jurisdictions in the western world face record high inflation, led by the US, the markets expect an end to quantitative easing and rise in interest rates simultaneously. The impact of the tapering is starting to being seen by way of insolvencies and now in equity markets. In the UK, the number of registered company insolvencies in December 2021 was 1,486, 20% higher than the number registered in the same month in the previous year, and 33% higher than the number registered two years previously. In addition there were 1,365 Creditors’ Voluntary Liquidations, which is 37% higher than in December 2020, and 73% higher than in December 20192.

The M&A and Tax insurance market remains well placed to provide solutions to wrap around a significant variation of deal dynamics, beyond the traditional disposal process. This article sets out further information on how M&A solutions may assist with complex, distressed dynamics.

1https://www.reuters.com/markets/europe/global-ma-activity-smashes-all-time-records-top-5-trillion-2021-2021-12-20/

2 https://www.gov.uk/government/statistics/monthly-insolvency-statistics-december-2021/commentary-monthly-insolvency-statistics-december-2021

Acquiring assets from an insolvency practitioner and synthetic warranties

Insolvency practitioners are not able to provide contractual recourse to a buyer when disposing of distressed assets on the basis they will know very little about the underlying business compared to a typical seller who has owned and operated it for a number of years and they do not wish to incur any personal liability.

To bridge this gap in protection, insurers can offer buyers a ‘synthetic warranty’ policy which gives the buyer effective recourse to an insurance policy in the event there is a breach of warranty.

Rather than the seller providing warranties in the share or asset purchase agreement, the warranties are ‘synthetically’ inserted into a W&I policy.

Given the dynamics of the transaction, primarily the lack of any disclosure exercise, insurers will generally offer a more limited range of warranties than they might expect to receive from a seller. Insurers will also expect to see detailed diligence carried out by the buyer. In addition to the synthetic warranties, it is also possible for the buyer to benefit from a synthetic tax indemnity. The policy would be subject to a sensible policy retention.

In the event the buyer’s diligence uncovers an identified risk, be it related to tax, potential litigation, IP or other contingent risks, other M&A insurance policies can be used to ring fence these risks and shield the buyer from potential future costs.

Sale by distressed sellers

Where sellers are in a precarious financial position, buyers may consider that they provide limited covenant strength, even if a fulsome warranty package is provided.

The use of an insurance policy in these circumstances, whether a W&I or contingent policy, provide a buyer with the comfort that they have recourse against an insurer with a strong credit rating and/or Lloyds capacity.

Sale of an indebted asset

Where a seller is selling a heavily indebted target business, the transaction may be structured so that the majority of the consideration provided by the buyer is injected directly into the target to allow that debt to be repaid in an efficient manner.

A W&I policy can be structured so that the total amount paid by the buyer is covered by the policy, however the language needs to be tailored so that ‘Loss’ is not limited to the consideration paid for the shares which may be a fraction of the total paid.

Investing in a business

Given that many businesses will be struggling for cash flow, they may seek capital investment from new investors rather than just taking on additional debt. Again, if structured correctly, W&I policies provide the investor with recourse in the event of a breach of warranties given by the existing owners.

The key benefits of this are (i) the investors do not need to bring a claim against their co-investors which could potentially sour their working relationship and (ii) if there is a breach of warranty and the target business has failed, the investors do not need to pursue the warrantors for their personal assets.

Restructuring financing arrangements

There can be tax risks associated with restructuring financing arrangements, whether it be writing off debt or undertaking debt-for-equity swaps, that can potentially lead to a material tax charge.

Tax liability insurance can be utilised to ring fence these issues and can also cover-off any associated interest, penalties and defence costs incurred in defending a challenge by a tax authority.

Intra-group reorganisations

Organisations may look to conduct intra-group reorganisations in order to streamline supply chains, ring fence struggling businesses, liquidate certain operations or in preparation of a disposal.

The more complex an organisation’s structure and the more jurisdictions involved, the greater the chance a reorganisation creates risk. Whether it be a tax risk due to transferring assets out of a group, IP risks due to moving assets around a group or litigation risks as a result of winding up a subsidiary, contingent insurance policies are an efficient tool to ring fence these risks, providing financial certainty as to costs of the reorganisation.

Preparing for sale

Regardless of whether the sale is destressed or not, we work closely with sellers’ and corporate finance houses that assist them in integrating M&A insurance at the beginning of the disposal process.

Whether it’s inserting the terms available for a tax liability insurance policy into the data room so that bidders have comfort that there is a solution to a known tax risk, or inserting the terms available for a W&I policy in the data room which the bidders can price into their offers, initiating the M&A process early means that there is transparency between the parties and allows for an efficiently managed transaction timeline.

COVID-19 will continue to present a whole host of challenges to both M&A and global markets. We are ready to work closely with you and your advisers to find the right solution for your situation.

Product Description Pricing Range*

W&I Insurance

Cover for financial loss incurred in relation to valid breaches of a warranty or representation pursuant to an acquisition agreement or a claim under a tax covenant or tax indemnity.

0.8% - 2.5%

Tax Liability Insurance

Cover for identified tax risks emanating from current, pending or historical transactions or reorganisations. Tax Liability Insurance can shift the responsibility for tax issues from the insured to the insurer, thereby minimising financial risks, uncertainty and associated exposures.

2% - 6%

Intellectual Property Insurance

Cover for financial losses suffered in connection with infringement lawsuits and IP invalidation proceedings, as well as to address indemnification claims related to a company’s IP or its products or services under contracts with several parties (including licensees, licensors, customers and manufacturers).

1% - 5%+

Title Insurance

Cover for a number of real estate and asset related risks. These include challenges to legal title, boundary issues, incapacity of prior owners, restrictive covenants, chancel repair liability, rights to light and missing searches.

0.1% - 1%

Liquidation Insurance

Cover to help to unlock capital held in reserves for legacy and contingent liabilities where investment funds are reaching the end of their fund lifespan or where corporate groups are looking to be rationalised.

1% - 4%

Litigation Buyout Insurance

Cover for a threatened, anticipated or current litigation, arbitration or dispute by ring-fencing the issue or providing cover in excess of the likely outcome.

3% - 10%+

Contingent Risk Insurance

Cover to offset the risks associated with identified contingent liabilities that are capable of legal and/or accounting analysis.

3% - 10%+


*Rate as a % of policy limit sought. Subject to minimum premiums. Fees and taxes in addition

About the BMS Private Equity, M&A and Tax Division

Every transaction is different and we pride ourselves on being able to structure bespoke M&A insurance solutions with the broadest coverage in a clear and concise manner.

We have access to insurance capacity across the world and have developed strong relationships with M&A and Tax insurance markets in London, Europe, North America and Asia.

Our team is a group of multi-disciplined professionals with backgrounds in M&A, Insurance, Law, Tax, Finance & Accounting, and Litigation. With our global reach and experience, we have extensive expertise of cross-border and domestic M&A transactions.

We partner with our clients and their advisers to help them navigate efficiently through the course of a transaction. This entails an in depth understanding of the transaction dynamic, our client’s commercial goals and identifying potential obstacles as early as possible. This process allows us to provide innovative insurance solutions which facilitate transactions regardless of the complexity, size and sector, all within your transaction timetable.

(Statistics below include transactions prior to joining BMS)

55

countries where we have supported transactions

1200+

global M&A deals advised on

$100bn+

of transaction value advised on

$18bn

largest transaction worked on

BMS is a dynamic, independent, global broker established in 1980, delivering specialist insurance, reinsurance, and capital markets advisory services.

Our teams are respected globally for their specialist market knowledge, intelligent analysis, insight and understanding.

Being independent makes a key difference to our clients, giving our brokers the freedom to deliver the best solutions, tailored to meet your business needs. Coupled with our collaborative team approach, single platform worldwide and renowned personal service.

More about BMS

Pawar Tan

Tan Pawar

Head of Private Equity and M&A

T: +44 (0)20-7480-0264
M: +44 (0)7341-133-007
More Info / Email Me

Andrews Dean

Dean Andrews

Head of Tax Liability Insurance

T: +44 (0)20-7480-0308
M: +44 (0)7876-815-643
More Info / Email Me

Wallace Sophie

Sophie Wallace

Divisional Director

T: +44 (0)20-7480-0378
M: +44 (0)7824-605-613
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Leitch Harry

Harry Leitch

Director, Head of Deal Origination

T: +44 (0)20-7480-0346
M: +44 (0)7770-990-368
More Info / Email Me

Simon stephan

Stephan Simon

Head of W&I Insurance – UK

M: +44(0)7785-720-944
More Info / Email Me

UK

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London EC3N 2LS
United Kingdom

T: +44 (0)20-7480-7288