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

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

3. 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?

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

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

6. 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)

7. Comparative size of warranty claims by claimant

8. Which warranties give rise to claims?

9. Categories of breach

10. Limitations on claims – Liability cap

11. 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

12. 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

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

14. 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

15. 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

16. 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

17. 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

18. 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

19. Transaction Liability Overview - Market and Players
Increased popularity: Estimate 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

20. 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

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

22. 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

23. 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)

24. 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)

25. 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)

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

27. 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

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

29. 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