Using insurance to facilitate business transactions
There’s an old African proverb which says that smooth seas do not make skilful sailors.
This would explain why most of those trying to get corporate, commercial, and real estate transactions over the line need the combined talents and stamina of Dame Ellen MacArthur and Sir Ben Ainslie. Dame Ellen once said that courage is not about having the energy to go on, but going on when you don’t have the energy. Many of you will know what this feels like, and how things are being made even harder by today’s business environment.
Business transactions falter for many reasons – some technical, some financial, and some personal.
Technical reasons may include an inability or unwillingness of the parties to negotiate away potential liabilities arising from matters such as regulatory exposures, environmental contamination, ongoing or threatened litigation, outstanding planning appeals, or employment disputes.
Financial reasons may include a mismatch of value expectations following due diligence, or a warranty gap in situations where one of the selling parties (often private equity) is not prepared to provide warranties beyond the fact they own the shares.
Personal reasons may include a change in family or business circumstances, or a concern that the transaction structure proposed may not attract the desired tax treatment a party expects.
It is, of course, up to each of the parties and their advisers to decide how, if at all, to attempt to rescue a faltering transaction. Most commonly, rescues arise when one party shifts their position to offer the other party an indemnity in respect of a potential liability. But indemnities of this nature are not always a viable or acceptable solution, particularly where the potential financial exposure under the indemnity is likely to be beyond the financial means of the party giving it.
Consequently, over the last decade or so, there has been a significant increase in the use of insurance products designed to remove transaction obstacles and facilitate deals being completed. New insurers are regularly entering the transaction insurance market, and the breadth of policy coverage and the level of insurance capacity available is growing exponentially.
In some circumstances, these insurance products completely remove the need for a party to give an indemnity and, in other circumstances, provide the financial collateral to underpin the resources of the party giving the indemnity. This should be to the benefit of all parties, of course.
Some insurance products may not be linked to indemnities contained in transaction documentation at all. For example, tax liability insurance policies are often structured to provide assurance to a party that a tax opinion regarding the expected tax treatment of a transaction is correct, and that resources will be readily available to robustly defend any challenge of the tax status of the transaction by the tax authorities.
Transaction-related insurance products currently available include warranty and indemnity insurance, environmental liability insurance and legal indemnity insurance (commonly known as title insurance). The market also provides cover for contingent liabilities (such as those arising from uncertain events like litigation, arbitration, intellectual property disputes, employment disputes and regulatory challenges), as well as cyber liability and tax liability.
So, confronted with a faltering transaction and with so much at stake, how can you and your advisers ensure that you have explored all potential insurance-related solutions, structured an insurance product correctly and satisfied yourself that it will be effective when called upon?
Two steps to success
Step 1 – Take advice from specialist insurance lawyers with transaction insurance experience
The role of specialist insurance lawyers in these situations is to work alongside your other advisers to review the relevant parts of the transaction documentation and advise on the legal aspects of any potential transaction insurance solutions. They will also assist the insurance brokers to review the policy wordings, recommend improvements and double-check that there are no unreasonable provisions that would prevent a proposed policy from responding to the risk being covered. After all, transaction insurance premiums can be a significant cost, and you will want to be satisfied you are getting value for money.
Step 2 – Take advice from specialist insurance brokers with transaction insurance experience
Specialist insurance brokers will ensure they have a clear understanding of the risks for which insurance protection is being sought, to enable them to access the right insurers, secure competitive policy terms and negotiate pricing. They will then recommend the most suitable policy or policies for you and support you through the underwriter’s pre-completion due diligence process. There are only a handful of genuine specialists in this market and it is important that you get into the right hands from the outset.
With your transaction advisers, insurance lawyers and insurance brokers working hand-in glove, you will have the best possible chance of securing the right insurance products to unlock your faltering transaction and allow you to focus on steering your deal to a successful conclusion.