M&A Risk Management: warranties, indemnities and insurance protections Friday 21 April 2017

Warranties: The Basics Richard Wise – Partner, Addleshaw Goddard LLP

Warranties and Indemnities Contractual protections for the benefit of a buyer Included in a share or asset purchase agreement Warranties Statements by the seller about a particular state of affairs of the target or business Breach: claim in damages for reduction in the value of the target or business Indemnities Promise to reimburse in respect of a particular liability Duty to mitigate?

Warranties Only as valuable as the warrantor(s) Limitations Awareness qualifications Disclosure Time limits Financial limits Split exchange and completion Repeating warranties ‘Lockbox’ mechanism

Key Themes and Trends of Warranty Claims Richard Wise – Partner, Addleshaw Goddard LLP

Who makes warranty claims? Corporate buyers more prevalent claimants Post deal teams to maximise return Cultural differences Previous recoveries can encourage claims Sending a message to the market (dishonesty/insufficient disclosure)

Comparative size of warranty claims by claimant

Which warranties give rise to claims?

Categories of breach

Limitations on claims – Liability cap

Limitations on claims – Other matters Notification periods not generally an issue assuming appropriate monitoring of the position by the buyer (1 - 2 years for non- tax warranties) Time limits for bringing a claim following notification should also be considered - allow at least a year to explore issues and negotiate? Basket/de minimis provisions not challenged Escrow amounts often inadequate for warranty claim values

Warranty claims – worthwhile? Well drafted warranties will help flush out issues pre-completion The majority of cases settled, with only 20% proceeding all the way to trial All buyer claims we reviewed resulted in a pay-out, save for one which settled on a drop hands basis Suggests buyers can achieve positive financial recovery

Warranty & Indemnity Insurance: Structure, Process and Use Anka Taylor – Director, Aon

Transaction Liability Product Overview Traditional TL Solution Relevant Trends Improve deal execution around unknown issues Indemnifications and/or escrows within the SPA Warranty & Indemnity (W&I) Allows cleaner exits, better IRR, streamlined negotiations Stable pricing with cover and capacity continuing to grow U.S. capacity per deal ~$500 million European/UK per deal ~ €600-€700m (depending on sector, jurisdiction etc) Most common of these issues are tax issues, which have been are usually addressed with a purchase price adjustments and/or tax opinion Tax Insurance The market has significantly expanded capacity in this space (~$700 million for a given deal) Pricing remains relatively steady at 3-6% depending on exposure Improve execution around specific deal issues The product is available worldwide, with highest market penetration in the USA, UK and Australia. Fast growing regions include Asia, South Africa and the Middle East. Policies are underwritten under a variety of governing laws (most common in EMEA UK, Dutch and German law). Policy durations differ between different warranty types, maximum period generally seven years. Aon Strategic Advisors and Transaction Solutions Proprietary & Confidential

Warranty & Indemnity – Why used? Risk Transfer Where sellers wish to protect their balance sheet against SPA claims. Shareholders who are looking to retire or who are trustees. Where buyers have concerns on recoverability of losses from sellers. Strategic Buyers using it in auctions as a tool to differentiate a bid. Where buyers wish to protect future business relationships. W&I policies where real estate deals via share sales becoming almost standard Deal issues Where the financial cap offered is for an insufficient amount or insufficient period Increasing scope of the deal warranties e.g. management warranty deeds. Warranty & Indemnity – Why used? Traditional Deal Security Measures Escrow, earn-outs or deferred consideration Ineffective use of capital Delays return of capital to investors or shareholders Risk of future litigation Delays valuation Bank guarantees Relatively expensive Third-party guarantee/indemnity May not provide sufficient buyer comfort Charge or mortgage over seller’s assets Not practicable if seller returning capital to shareholders or investors Price chipping Unattractive for sellers and does not quantify risks for buyers Aon Strategic Advisors and Transaction Solutions Proprietary & Confidential

Warranty & Indemnity – how it works W&I insurance protects an insured party from losses resulting from breaches in warranties given by sellers or from claims under indemnities Covers losses arising out of an unexpected or unforeseen breach of general or specific warranties or claims under a tax indemnity W&I policies can be taken out by the buyer or the seller The policy attracts a ‘one time’ premium at inception Covers unknown matters only Bespoke terms tailored to each transaction Cover of indemnities depends largely on the specific case Insurers expect a balanced warranty package, appropriate due diligence and a comprehensive disclosure process Proprietary and confidential 16

Warranty & Indemnity – Buyer Example Situation: The buyer(s) is the insured. Requesting coverage against financial loss suffered as a result of a breach of the seller’s warranties.   Solution: Warrantors give warranties but these are capped at a lower amount, the insurance policy sits in excess of this. Policy is independent of the seller, therefore the buyer is entitled to make a claim directly against the policy Sale & Purchase Agreement Transaction value Buyer’s risk Insurance policy Policy limit (buyer’s risk appetite to determine limit) Policy to protect against financial loss Limitation of liability for breach of warranty under the SPA Seller’s risk Aon Strategic Advisors and Transaction Solutions Proprietary & Confidential

Warranty & Indemnity Insurance Policy Terms Excluded Matters Common exclusions: Matters known to either party at completion Fraud of the insured party Consequential losses Forecasts/forward-looking warranties Contamination/pollution Inadequacy of business insurance cover Fines and penalties uninsurable at law Pension underfunding, transfer pricing and secondary tax Post-closing price adjustments/leakage indemnities Bribery or corruption Transaction-Specific Exclusions: Known or high-risk environmental issues Disclosed or known issues that are typically subject to a specific indemnity Coverage Basics Broadest cover for warranties that are: Fairly balanced and in sellers’ scope of knowledge Capable of factual verification Not forward looking Typical transactions: Private transactions with a purchase price of £10 million to £2-3 billion Pricing: typically 1% - 2.5% for most EMEA deals Retentions: 1-3% of transaction value; minimum retention usually 0.75%. Tipping to nil if real estate. De minimis: 0.01% of transaction value generally Policy period: Mirrors or extends underlying agreement, up to 7 years Proprietary and confidential

Transaction Liability Overview - Market and Players Increased popularity: Estimate 1000+ policies underwritten in the US, Asia Pac EMEA (the majority in the UK, Nordics and Germany) in 2016 industry wide. Insurance market well-developed (mix of company, Lloyd’s syndicates and MGU) Insurance companies and Aon are staffed by former M&A lawyers who work on deal timeframes Policies are customised and underwriting process streamlined New market entrants during 2016 – Chubb Reinsurance is provided by several well known markets – Swiss Re, Partner Re, Munich Re, Hanover Re as well as some other smaller markets Transaction Liability Overview - Market and Players Aon Strategic Advisors and Transaction Solutions Proprietary & Confidential

Warranty & Indemnity – Underwriting Considerations Sector of target Geographical spread of target operations Domicile of insured Governing law of SPA and policy Transaction value Insurance limit sought Quality and scope of DD - whether seller or buyer Robust negotiations and full disclosure exercise Scope and breadth of warranties Indications of endemic issues within target These are all fundamental u/w considerations and then secondly will go to pricing Warranty & Indemnity – Underwriting Considerations

Warranty & Indemnity Insurance: Claims Richard Wise – Partner, Addleshaw Goddard LLP

Claims experience Relatively limited data Growth market: Howden reported 55% more policies in 2015 than 2014 Marsh reported 32% more policies in 2015 than 2014 Notifications AIG report 1 in 7 policies globally give rise to a notification Lockton estimate 13-16% of policies give rise to a notification

Alleged Breaches – AIG’s Claims Data (2011 - 2014) Financial statements: 28% Tax: 13% Contracts: 11% IP: 10% Employee: 8% Litigation: 8% Compliance 5% All other: 17% Reflects pattern seen in underlying / uninsured warranty claims data Accounting / financial warranties Source: What Happens After the Deal Closes? AIG (2017)

Timing – AIG’s Claims Data (2011 - 2014) 0 – 6 months: 25% of notifications 6 – 12 months: 27% of notifications 12 – 18 months: 22% of notifications 74% of notifications within first 18 months post-close Reflects pattern seen in underlying / uninsured warranty claims data 2 years / audits Source: What Happens After the Deal Closes? AIG (2017)

Deal Size – AIG’s Claims Data (2011 - 2014) Does this reflect a well considered and funded DD process in mid-market? Source: What Happens After the Deal Closes? AIG (2017)

Warranty & Indemnity Insurance: Innovations Anka Taylor – Director, Aon

Warranty & Indemnity – Innovations Innovation in coverage Scope of the warranties can be extended beyond the terms in the SPA - removal of awareness qualifiers Policy can increase the caps on liability beyond those in the SPA – both financial and time limitations US style coverage available where underlying SPA incorporates US features including materiality scrapes, more limited disclosure regime, measure of loss on indemnity basis Benefit of the policy can be assigned to finance parties Synthetic tax coverage Innovation in usage Increasing use of W&I product by sellers in auctions Rise of repeat institutional buyers – able to leverage market to get better pricing or coverage

Warranty & Indemnity Insurance: The future? Richard Wise and Anka Taylor

The future? The quality of the due diligence and its interaction with the underwriting process Exclusions and the value of the insurance product The role of the sell side flip Claims