transaction liability insurance: a strategic approach to
TRANSCRIPT
Prepared by Aon Strategic Advisors and Transaction SolutionsAon Transaction Solutions
Transaction Liability Insurance:A Strategic Approach to Deal Risk Management
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Aon ContactMatthew B. WienerSenior Vice President
Matthew Wiener is the head of Aon’s’ Transaction Liability team for the Southwest region. Inthis role, Mr. Wiener is responsible for the development and implementation of transactional-based risk solutions, including the deployment of insurance capital for M&A transactionsthrough representations and warranties, litigation, tax and other contingent liabilities insurance.Mr. Wiener is based in Houston and is further supported by a New York-based team of 20professionals in North America and colleagues in London, Hong Kong, Sydney and Bermudawho focus exclusively on transactional risk transfer. Prior to joining the Aon Team, Matthewwas an attorney at Vinson & Elkins LLP, where he specialized in corporate finance andsecurities law matters, including mergers and acquisitions, private equity, public and privatesecurities offerings, divestitures, and general corporate representation.
Matthew is a graduate of The University of Texas with a BBA in Finance and GeorgetownUniversity Law Center with a Juris Doctorate degree.
Contact InformationOffice: 713-470-9794Email: [email protected]
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Insurance Capital Overview
2
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Transaction Liability Insurance Capital — The PrincipleThe availability of insurance capital designated for transaction liability has expanded significantly over the last five years. The most substantial use of this capital is through the deployment of Representations & Warranties (R&W) insurance. R&W insurance covers liabilities arising out of a breach of one or more of the R&W in an M&A transaction (including financial statements, intellectual property, taxes, and compliance with law). Policies are tailored to address a client’s specific indemnity and risk and exposure allocation needs on any given transaction.
• Policies are negotiated and drafted to replicate the traditional indemnity/escrow found in most transaction agreements, with an aim to put Buyer in the same (if not better) position regarding financial loss exposure.
• R&W insurance policies can cover all R&W contained in the transaction agreement, including both general and fundamental R&W, as well as pre-closing tax indemnities.
• Structure (including Seller indemnity and Buyer deductible) depends on objectives of parties and policies can be designed to back-stop Seller indemnification obligations and/or function as Buyer’s sole source of recovery.
3
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Transaction Liability (TL) Insurance — A GrowingMarket
The use of Transaction Liability Insurance has grown dramatically over the past four years
4
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Transaction Liability Insurance Market and Players
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Representations and Warranties Insurance
Representations and Warranties Insurance
6
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Sell-Side Strategies and Value Enhancement -Overview R&W insurance serves to significantly reduce (or in some cases replace) the typical indemnity/escrow arrangement that a Buyer will generally require a Seller to agree to in an M&A transaction.
• In the absence of a R&W policy, a Buyer often requires that a Seller place 10% or more of the purchase price in escrow (or contractually agree to be liable for such amounts) to satisfy any losses incurred as a result of a breach of the R&W that the Seller makes under the transaction agreement.
• The R&W policy can significantly reduce (or in some cases eliminate) this indemnity obligation, thus allowing the Seller to immediately substantially all of the proceeds from the transaction and effectuate a cleaner exit.
• Sellers will frequently arrange to implement R&W insurance as an option at the start of a sales process such that the Seller can introduce a more favorable indemnity structure from the outset of the process, ensuring that the overwhelming majority of purchase price received by the Seller from the sale is unencumbered by potential future obligations.
7
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Representations and Warranties InsuranceRepresentations and Warranties insurance allows sellers to close a deal with limited or no indemnity and can make a buyer’s bid more attractive.
Traditional Deal Structure
*Seller may cover a share of policy premium
$90MMNet Proceeds
at Closing
$10MMProceeds at
Risk
$99.5MMNet Proceeds
at Closing
$0.5MMProceeds at
Risk
Representations & Warranties Policy
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Sell-Side Strategies and Value Enhancement —ConsiderationsPrivate Equity Utilization and Benefit• Private Equity use of “seller-flip” model has dramatically increased over the last two years.
– Greater acceptance by corporate/strategic buyers as well as familiarity by law firms and financial advisors has played a significant factor
• R&W structure enables PE to return more capital immediately to LPs upon fund exit (as opposed to significant funds being subject to an indemnity period), reducing equity claw-back exposure and mitigating post-close transaction liabilities.
• PE ability to redeploy escrow capital into high-return investments (as opposed to a low-interest escrow account).
• Exclusion of subrogation of claims against Seller, absent fraud.
Seller Engagement• Broker engaged by Seller prior to marketing to solicit preliminary carrier interest in underwriting
transaction.
• Carriers provide initial pricing terms and coverage in 2-4 days.
• Broker prepares Process Letter providing overview of R&W Insurance coverage from carriers which is provided to buyers participating in auction process.
• Winning bidder engages Broker to implement and negotiate R&W insurance policy.
– Nothing further is needed or required from Seller.
9
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Buy-Side Implementation and Risk Allocation —OverviewBuyers are incorporating insurance capital into their bids, reducing Sellers’ indemnity obligations, and insuring up to more market levels.
• The use of insurance capital in M&A transactions has increased exponentially primarily as a result of two key factors:• “Mandated” by seller via Seller-Flip process or through indemnity structure built into the draft
transaction agreement• Used as a bid a differentiator in competitive auction processes.
• In a sales process “mandate”, Seller will introduce a limited/no-indemnity structure in the transaction agreement and instruct prospective buyers to seek R&W insurance to cover losses incurred as a result of R&W breaches.
• Buyers frequently look to utilize R&W insurance at the start of a sales process to facilitate enhancing a buy-side bid. In the event, a limited/no-seller indemnity structure how not been incorporated from the outset, a Buyer is often able to either shut down an auction process or offer a reduced valuation given the benefit the Seller is receiving through this structure.
10
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Buy-Side Implementation and Risk Allocation —ImplementationThe implementation of R&W insurance can be broken-down into a three-step process consisting of (i) initial Underwriter quoting, (ii) underwriter diligence and (iii) policy negotiation and execution.
• Initial Underwriter Quoting• Broker and underwriters enter into Confidentiality Agreement with prospective Seller/Buyer.• Broker submits documentation to underwriting syndicate to obtain high-level quotes and interest in
underwriting transaction. Requested documentation to provide initial terms usually consists of:» Sell-side marketing materials (CIM/CIP/Management Presentation)» Audited financials (if available); QofE Report» Buyer/Seller draft of transaction agreement.
• Initial quotes are generally obtained within 3 days, and Broker prepares a Summary comparing pricing, coverage and other terms from each quoting underwriter
• Underwriter Diligence• Upon engagement of an underwriter, formal diligence begins and typically lasts 2-4 days.• Underwriters engage outside counsel to review diligence performed by Buyer and its advisors on a non-
reliance basis.– No additional diligence is required of Buyer beyond what has already been performed.
• The diligence process culminates in an underwriter call with Buyer and its advisors to walk through any outstanding questions/issues the underwriter may have.
• Underwriter Diligence• Once diligence has been complete, underwriter will prepare and submit an initial draft of the policy.• Broker and Buyer’s counsel will negotiate the R&W insurance policy.• Policy is generally finalized within 1-2 days and signed concurrent with the execution
of the transaction agreement.
11
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
R&W Insurance – Process and Timing
1 2 3 4 5 6 7 8 9 10 11 12+
Day 1Engage broker early in processBroker and potential Insurers execute (joinder to) NDA
Day 5Select Insurer• Insurer due diligence fee payable before underwriting ($10K-$40K)
Day 3 - 5Obtain quotes from Insurers• Submission includes recent draft agreement, offering memorandum, schedules,
and audited financials• No cost to obtain quotes
Day 5 to 12+Insurer Underwriting (7-10 days process), Policy Negotiation• High-level review of due diligence process• Access to legal, financial, tax due diligence reports, subject to non-reliance letters• As with providing legal reports to lenders, loss of attorney-client privilege• Telephone conference(s) with deal team
12
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Representations and Warranties Insurance: Enhanced Indemnity
Survival Period
Limits Materiality Scrape
Definition of Loss
A buyer-side representation & warranties insurance policy may enhance a buyer’s potential for recovery rather than simply replace the typical seller’s indemnity.
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Corporate/Strategic Acquirer UsageAon placed 94 R+W policies for strategic acquirers in 2016. 95% were buy-side and 5% were sell-side policies. Two-thirds of the 94 policies were purchased by public companies.
14
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Value Creation in Distressed Transactions
15
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Value Creation in Distressed Transactions - OverviewR&W Insurance can make a significant impact in distressed deals by providing indemnification protection to a buyer where none would otherwise be available:
Increase competition and return to creditors
Protect buyer against loss of value based on misrepresentation
Provide buyer with a creditworthy counterparty where indemnification is available, but effectively meaningless
Given the current dislocation in the energy markets and the increase in bankruptcies and distressed deal flow as the market reconfigures, the synergies between the deployment of insurance capital and the allocation of risk away from parties engaged in the distressed deal marketplace are now more pronounced.
16
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
As with non-distressed deals, the R&W Insurance would protect the insured for liability resulting from unknown breaches of the company’s or seller’s R&W in the transaction agreement
Coverage would match traditional, non-distressed M&A indemnity structure, with limits available up to 100% of enterprise value
Policy period would be three years for general reps; six years for fundamental and tax reps
Cost could range from 3% to 5% of the limit purchased, based on deal and target specifics
Self-insured retention is typically 1-2% of enterprise value, and buyers may be able to negotiate seller’s retention of a portion of the retention risk
Carriers can also entertain underwriting transactions where no seller indemnity is required (i.e., the self-insured retention would be borne solely by buyer)
R&W Insurance – Application in Distressed Transactions
17
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
R&W Insurance – Section 363 SalesDebtor-Seller negotiates asset purchase agreement (“APA”) with proposed stalking horse bidder-buyer
Broker prices ‘stapled’ RWI to be available to winning bidder, subject to completion of underwriting
Bankruptcy Court approves stalking horse bidder and payment of RWI policy costs at closing of sale
Debtor-seller selects highest/best bid at auction and carrier completes underwriting with winning bidder
Based on insurer underwriting results and negotiated R&W language in final APA, final terms of policy are negotiated and policy is bound at closing, with policy costs paid at or shortly after closing
18
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
R&W Insurance – Chapter 11 Plan SalesSeller-Plan proponent includes asset purchase agreement (“APA”) in proposed chapter 11 plan
Broker prices ‘stapled’ RWI to be available to winning bidder, subject to completion of underwriting
Bankruptcy Court approves payment of RWI policy costs following plan proposal at closing of sale
Plan proponent-seller selects highest/best bid at plan auction and carrier completes underwriting with winning bidder
Based on insurer underwriting results and negotiated R&W language in final APA, final terms of policy are negotiated and policy is bound at closing, with policy costs paid at or shortly after closing
19
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
R&W Insurance – Prepackaged PlansSeller-Plan proponent includes asset purchase agreement (“APA”) with or without pre-selected buyer in proposed chapter 11 plan
Broker prices ‘stapled’ RWI to be available to winning bidder, subject to completion of underwriting
Bankruptcy Court approves payment of RWI policy costs following plan proposal at closing
Plan proponent-seller selects highest/best bid at plan auction and carrier completes underwriting with winning bidder
Based on insurer underwriting results and negotiated R&W language in final APA, final terms of policy are negotiated and policy is bound at closing, with policy costs paid at or shortly after closing
20
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Tax Insurance
21
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Tax Insurance Protection in Distressed TransactionsWhat is tax insurance?
Tax liability or tax opinion insurance can help a company reduce or eliminate an unwanted or contingent liability arising from a successful challenge by the I.R.S. or a foreign or state and local tax authority of a company’s tax treatment of a current, pending or historical transaction or investment
What is covered?
Failure of the insured to achieve the expected tax treatment in a transaction (M&A, lease, partnership or financing transaction) or an existing/ongoing corporate tax issue
U.S., state, local or foreign taxes
Tax, contest costs, interest, penalties and gross-up
Policy limits available from $10million to ~$1billion
Policy term typically 6 years; claims made
22
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Advantages of Tax Insurance Tax Liability or Tax Opinion Insurance protects buyers against a successful challenge by the IRS or other foreign, state or local tax authority and can help sellers close their deal more quickly.
Manages counterparty
exposure
Achieves economic certainty
Protect tax positions from
challenges
Eliminates the need
for escrow
Reduces uncertainty
in cross-border deals
Streamlines negotiations by eliminating deal-breaking issues
Challenges from U.S., state, local
or foreign tax authorities
Failure to achieve
expected tax treatment
Recovery for tax, contest
costs, interest, penalties and
gross-up
Retroactive change in
tax law
What is CoveredKey Benefits
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Tax Insurance
S corporations
Tax-free reorganizations/mergers
Section 355 spin-offs
REITs/real estate acquisition/sales
Partnership issues
Employee benefits issues
NOLs
Federal and State Tax credits (e.g., solar ITC, low income housing)
*Tax Shelters (listed transactions) are not insurable
Tax neutral reorganizations Availability of degrouping relief Debt for equity tax relief Substantial shareholdings
exemption (SSE) Offshore and residency issues REITs
When to Consider Tax Insurance
USA UK/Europe
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Litigation and Specialty Insurances
25
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Litigation InsurancePending or potential litigation can expose buyers to significant risks and financial liability. Litigation insurance can offset that risk or limit the liability buyers will be responsible for once the deal is complete.
When to consider Litigation Insurance
Possibility of a catastrophic outcome
Likely attachment point or retention due to potentially large range of damages
Pending litigation is preventing a deal from closing
Litigation arguments are well developed
M&A Deals Helps sellers avoid substantial escrow
requirements Allows buyers to ring fence the cost of
damages from an adverse judgement
Ongoing Business Risk Management Protects companies from catastrophic loss
from an adverse judgement
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
CFIUS Reverse Break Fee InsurancesChinese buyers may be subject to review by the Committee on Foreign Investments in the US face placing them at greater risk that their acquisition of a US asset will not be approved. CFIUS Reverse Break Fee Insurance helps Chinese buyers stay on an equal footing with US and other foreign bidders.
What is Covered
CFIUS Reverse Break Fees
(less self-insurance retentions or deductible)
Landscape Increased appetite for foreign
investment in the US Seller requests for buyer to
pay reverse break fees when deals fail
Inability of non-US investors to absorb the risk of paying out break fees
Broken Deal Costs(legal and banking
fees and expenses)
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
Transaction Liability: Claims
28
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
R&W Insurance — Claims History
29
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential
R&W Insurance – Frequency and Timing of Claims
30
Aon Strategic Advisors and Transaction Solutions | Aon Transaction Solutions 31
Transaction Liability Insurance & Claims: Aon Policies
*More claims for policies that incepted in 2015 and 2016 are likely forthcoming
Percent of Aon policies that resulted in claims
When to consider Litigation Insurance
14
119
87
665
3.92016*
%
12.62015*
% 17.62014
%
Prepared by Aon Strategic Advisors & Transaction SolutionsProprietary & Confidential32