Ole Aabø-Evensen and Harald Blaauw of Aabø-Evensen & Co in Oslo look at the issues surrounding M&A insurance
Background and developments
During the last year and a half, we have witnessed a significant uptick in usage of M&A insurance (i.e. commercial insurance of SPA warranties and indemnities) in Norwegian M&A transactions – rising steadily, from a sequential perspective, from virtual nonexistence in 2012 (when only four policies were taken out) to a progressive policy count of 33 in 2014. Whether this upward trend continues in 2015/2016 remains to be seen, but as declining oil prices lead to a dry spell for oil and gas deals at the start of 2015 followed by substantial reductions in the average deal-sizes for Norwegian M&A transactions, the policy count may well keep rising proportionally. Nonetheless - and irrespective of market climate going forward - there can be little doubt that the institute of M&A insurance has now gained enough traction to be considered a (likely) permanent and familiar instrument in the Norwegian M&A toolbox – which, from a practitioner's point of view, is always a positive development.
Although industrial actors (amid seemingly unbridgeable warranty stalemates) have increasingly noticed the mitigating qualities of M&A insurance, the frontrunners in the above-mentioned developments have been private equity (PE) funds in need of clean exits without escrows or claw-back undertakings. Having acted as legal advisor for the seller, the buyer or the insurance provider in a vast number of the Norwegian transactions that have utilised M&A insurance, this PE backdrop might explain our observance of a (non-definitive) prevalence towards buy-side policies, whereby the buyer (and not the seller) becomes the policyholder on closing, and the PE vendor, rid of all risks, practically leaves the picture.
In our view, many buyers (whether industrial or PE) also perceive buy-side policies as more intuitive than sell-side policies (where the seller becomes the policyholder on closing), which might be attributed to a sense of predictability; when being offered an SPA with an already tailored and integrated insurance package, the prospective buyer knows exactly what is on the table (and what is not). For various reasons, it may also be more beneficial (and comfortable) for a buyer to claim warranty breach under the SPA against an 'impersonal' insurance company, than against a potential business partner (e.g. co-investing/rolling management).
Looking at the available Norwegian market statistics, M&A insurance premiums are typically in the neighborhood of 1–2% of the policy coverage (i.e. the total liabilities/warranties insured), and the retention (i.e. the deductible that the policyholder must absorb before the insurance applies) is usually 1% of the transactional value (i.e. the target's enterprise value). In terms of quick statistics, the claims frequency in Europe from 2002 until 2013 was 12 % (compared with 28 % in the US), and claims predominately arose in transactions involving the manufacturing industry. The most common types of breach pertains to misrepresentations in respect of tax, financial statements, valuation multiples and real estate.
The liability gap – caveat emptor
Despite having established itself as the vendors' preferred avenue for transactional risk mitigation in relation to SPA warranties (particularly for PE vendors), M&A insurance is still a relatively new transactional instrument in the Norwegian market, and there is still some unresolved skepticism about the product. Parties contemplating M&A insurance are particularly concerned about the actual extent of effective policy coverage, and, if push comes to shove, how a potential settlement process will transpire.
The latter chiefly stems from lack of any discernable industry track record in respect of settlements, and this issue will probably conclude itself in due course. The former, however, is more tangible and goes directly to the applicability (and suitability) of the product; namely whether there is congruence between the SPA warranty catalogue and coverage offered under the policy, or whether fine-print exclusion clauses will trip up ostensibly straightforward settlements and involuntarily force parties into lengthy court cases against insurance companies. Incongruence or nonconformity between the SPA warranty catalogue and the policy coverage is often referred to as the "liability gap", and may be likened to the contractual principle of caveat emptor ("let the buyer beware"); if not adequately considered and preferably bridged, a buyer's seemingly resilient insurance policy may turn out to be hollow promises with little recourse.
In our experience, there are four main liability gaps (caveats) (although not exhaustive), that a policyholder risks falling into if he, or his team of advisors, does not exercise vigilance and due care.
1. The first is the knowledge caveat, whereby most insurance policies exclude coverage for any fact, matter or circumstance known to the policyholder prior to closing of the transaction, which 'might reasonably be expected to give rise to a warranty claim' under the SPA. In relation thereto, policies often also require policyholders to have undertaken all 'measures that reasonably could be requested by a diligent buyer' in order to obtain such information, which, if so provisioned, effectively widens the knowledge qualifier from known (under the SPA) to should have known (under the policy).
2. The second liability gap, is the typical policy exclusion of any 'estimate, projection, forward looking statement or financial forecast' pertaining to an insured SPA warranty. With this exclusion, a buyer's traditional attempt to hedge against the seller suppressing founded suspicions about future events (e.g. by tailgating SPA warranties with "…nor does the seller suspect or foresee any such circumstance materializing in the imminent future") become futile, and should either be abandoned or adequately dealt with outside the warranty catalogue (e.g. through additional disclosures or deliveries).
3. The third caveat in policy coverage is that of various defense and mitigation rules, where the policyholder in relation to the latter is required to act at all times as 'uninsured', and, which often is stricter than what is stipulated in the SPA, 'take all reasonable actions necessary or advisable to mitigate any loss or potential loss'. What fiduciary duties the insurance companies will hold the policyholders to in relation to such mitigation rules (and similar vague provisions) remains to be seen, but leniency is not to be expected.
4. The fourth and final caveat in terms of liability gaps between SPA warranties and policy coverage is the list of exclusions designated in a separate spreadsheet accompanying the policy. Items frequenting this list (either as excluded or only partly covered) may include taxation, intellectual property rights, “true and fair” warranty relating to unaudited financial statements, pension underfunding and environmental matters.
As can easily be deduced from the above, the consideration of whether M&A insurance is advisable in a given transaction requires a bit more insight and contemplation than the average cost/benefit analysis, and must be decided on a case-by-case basis. Missing a few steps at this stage may lead to quite sobering questions in the wake of closing, like; whose risk is it anyway?
Aabø-Evensen & Co
About the author
Ole K Aabø-Evensen, co-head of M&A at Aabø-Evensen & Co, assists industrial investors, financial advisors, private equity funds, as well as other corporations in friendly and hostile take-overs, public and private mergers and acquisitions, corporate finance, securities law and other corporate matters. Ole has an extensive practice covering all relevant aspects of transactions, both nationally and internationally and is widely used as a legal and strategic advisor in connection with the follow-up of his clients’ investments. Aabø-Evensen is also the author of a 1,500 pages Norwegian textbook on M&A and numerous articles on mergers and acquisitions in various international publications. In an annual independent peer review, published by Norway’s leading financial newspaper Mr Aabø-Evensen has several times been named as Norway's No 1 M&A lawyer. Ole is a former partner and head of corporate legal services and M&A at KPMG in Norway.
Aabø-Evensen & Co
About the author
Harald Blaauw, co-head of M&A litigation at Aabø-Evensen & Co, primarily advises clients on general corporate and commercial law, M&A, stock exchange and securities and transactional-related matters. Harald has extensive experience with strategic takeovers, structured sales and acquisitions (herewith cross-border) and corporate litigation, and has been recognised as a leading advisor for his involvement in many of the most prominent private equity transactions in the Nordic region during the last years. Harald has also acted as authorised arbitrator in a number of civil and criminal disputes before the Philadelphia Municipal Court and the Philadelphia Arbitration Center, and is admitted both to the Bar of New York and the Bar of Norway.