Your client has been looking for just this opportunity for some time. This acquisition, he tells you, is the perfect marriage and will allow the company to finally capitalize on the platform it has so diligently been preparing. All is on track, until the transaction due diligence exercise reveals an unexpected development.
Perhaps you have been there before, an otherwise mutually beneficial transaction is on the brink of closing when an unexpected obstacle presents itself. The prospective buyer sees the benefit of the transaction, but can't seem to get comfortable with the potential impact of an adverse outcome of a disagreement or contingency unearthed in the due diligence undertaking. Historically, the potential solutions for such a predicament were limited: establishment of an indemnification agreement or use of an escrow, modification of the deal economics, or perhaps abandonment of the transaction altogether. Now however, there is another potential solution: Transactional Insurance.
We all know something about the numerous business and personal insurances that are available. What most people, including many insurance brokers, do not know is that there are insurance products, which protect against the financial fall-out resulting from contingencies that may be preventing completion of your clients' business dealings. Transactional Insurance is designed to bridge the gap between negotiating parties in a wide variety of business transactions by providing an insurance solution for deal points or contingencies that may otherwise impede or prevent the closing or completion of a transaction. These contingencies can include, among others, a multitude of tax or legal issues.
What types of transactions can be facilitated by Transactional Insurance products?
Transactional Insurance products can be tailored to address issues that arise in just about any type of commercial business transaction. Moreover, Transactional Insurance can be used to address numerous types of underlying contingencies; from questions regarding the size, scope, security and duration of an indemnity, to the existence of litigation or a legal contingency. Some examples of the types of transactions that might benefit from a Transactional Insurance solution include:
Transactional Insurance can provide the insured with an increased level of comfort over that which might be found in a sellers indemnification agreement by expanding the time period, breadth, or amount of the indemnity. Transactional Insurance can provide a more efficient use of capital than the more traditional methods of indemnification such as letters of credit, escrow accounts and balance sheet reserves. In the case of concern over a contingency, Transactional Insurance can provide a means to reduce the ramifications of the unlikely, yet possible, occurrence of the contingency. Thus, Transactional Insurance can be used to bring the potential impact of a remote event in-line with the economics of the transaction.
What are Transactional Insurance products?
Generally, Transactional Insurance products address one of two categories of exposure; disclosure risk and legal interpretation risk. Disclosure risk refers to the exposure associated with the misrepresentation of past activity and is commonly addressed through Warranty & Indemnity Insurance (or Representations & Warranties Insurance as the product is referred to in the United States). Warranty & Indemnity Insurance is designed to address disagreements between negotiating parties as to the structure, scope, or amount of the indemnity obligation to be established to apply to breaches of warranties and indemnities made in a transaction agreement. The insurance can be obtained on behalf of the seller to reimburse the seller for losses incurred under its indemnification obligation to the buyer. Warranties & Indemnity Insurance can also be obtained for the benefit of the buyer in a transaction and can provide ""top-up"" coverage over and above the indemnification provided by the seller. In this regard, Transactional Insurance can be used strategically by either the seller or the buyer to enhance, supplement or replace the traditional means of backstopping the factual accuracy of the warranties and indemnities made in a transaction agreement.
Transactional Insurance can also be used to address an actual or perceived risk of unintended legal interpretation. Legal interpretation risk refers to the exposure associated with the possibility that despite apparent present clarity on the intended consequences of a particular set of facts or circumstances, in the future such facts and circumstances might be interpreted differently. By way of example, with the benefit of hindsight, might a finder of fact in the future, such as a regulator, court or arbitrator, interpret the facts and circumstances differently and reverse the previously intended result of specific tax planning, or overturn the conclusion reached by a lower court.
Various Transactional Insurance products are designed to address different types of legal interpretative exposure including Tax Insurance and Contingency Insurance. Tax Insurance is designed to respond to legitimate tax issues that arise in connection with a variety of transactions. The inability to obtain an expected tax treatment may have such a significant financial impact on the proposed transaction that without certainty, the parties involved will become unwilling to complete the transaction. Tax Insurance can provide assurance of receipt of a specific tax treatment in cases where no clear guidance exists or where certainty cannot be received in the required timeframe necessary to complete the transaction. Of note, Tax Insurance is not available for tax shelters or planning deemed abusive by the relevant taxing authority. Contingency Insurance is designed and structured to address deal points that arise out of unique contingencies such as the risk of clawback which might be particularly attractive to a private equity fund seeking to add finality to a distribution made to its investors.
What is the Process?
Transactional Insurance is best structured if it seamlessly ""backs-up"" to the underlying transaction agreement. This favorable result is best accommodated by securing Transactional Insurance from the relatively small group of underwriter practitioners that are specialists in Transactional Insurance.
Recent events in the world financial markets have had an unmistakable effect on the private equity and M&A markets. However, it is important to note that Transactional Insurance solutions reach far beyond simply M&A transactions. Rather, Transactional Insurance is being used, on an increasingly frequent basis, to facilitate all types of business transactions including those arising in the context of restructuring and bankruptcy. The client-focused insurance broker is wise to keep abreast of the potential uses of Transactional Insurance and how these innovative insurance products can help add value to the business enterprise of their clients.
Jeffrey Cowhey is President and Chief Operating Officer of Ambridge Partners LLC, a managing general underwriter of Transactional Insurance products on behalf of interested underwriters at Lloyds of London and CNA.