1. R&W Insurance as a Tool for Strategic Buyers and Sellers
Association of Corporate Counsel
December 12, 2016

2. 01 02 03 04 Agenda Background and Market Trends
R&W Insurance Policy Nuts and Bolts 03
R&W Insurance as a Tactical Tool 04
Conclusions and Q&A

3. Background and market trends01
Background and market trends

4. Overview
What does Representation and Warranty (R&W) Insurance cover? How much of the typical indemnity and escrow/holdback framework does it replace?
What are typical pricing terms?
What are the steps to obtaining a policy?
How does the post-closing claims process compare to a typical indemnity claims process?
When might it be in the interest of a strategic Buyer or Seller to use R&W Insurance?

5. Recent Growth in the R&W Insurance Market
Concept of R&W Insurance has existed for more than 20 years, but market only began to develop in a significant way more recently
Buyers reluctant to rely on what they viewed as an untested product
Pricing terms were prohibitively high in many cases
U.S.-based buyers would encounter it occasionally in acquisitions involving European targets
Significantly more insurance capital available in the last five years
Pushed in the U.S. by private equity sellers
Desire to pay proceeds to limited partners quickly and without risk of clawback
Also becoming popular with risk-averse sellers (founders/individual sellers)

6. Strategics Making Greater Use of R&W Insurance
Use of R&W Insurance by strategic Buyers and Sellers has grown substantially in the past two years
Previously 80/20 PE/Strategic; now closer to 60/40
Not just strategic Buyers being mandated to use by PE Sellers

7. Role of R&W Insurance in an M&A Transaction
R&W Insurance covers liabilities arising out of a breach of one or more of the R&W made by a Seller in the purchase agreement
This is risk that would ordinarily be allocated to the Seller, subject to negotiated limitations
Structure (including Seller indemnity and Buyer deductible) depends on objectives of parties
Policies can be designed to supplement Seller indemnification obligations or function as Buyer’s sole source of recovery
More commonly associated with mid-market M&A transactions but can be used in connection with $1B+ deals

8. Insurers Now in the R&W Market
600+ policies underwritten in the U.S. in 2015 industry-wide

9. R&W Insurance Policy Nuts & Bolts02
R&W Insurance Policy Nuts & Bolts

10. Typical Indemnity Framework
Private transactions involving strategic Buyers and Sellers historically have relied on a customary indemnity framework
Seller makes a variety of R&W to the Buyer about the condition of the business or assets being sold
Usual post-closing recourse for R&W breaches is the Seller's indemnity
Buyer might insist on escrow/holdback arrangement depending on creditworthiness of Seller
Indemnity framework generally highly negotiated

11. Common Focuses of Negotiation
Sellers seek to limit liability
Narrowed scope of R&W, qualified by materiality or knowledge
Short survival period for many R&W
Lower caps on overall liability and larger baskets before indemnification obligation is triggered
Higher thresholds before a Buyer can bring a claim
Buyers seek comfort they can recover for significant claims
Holdbacks and escrow arrangements provide security for a buyer's claims but a seller may be resistant to tie up a significant portion of sale proceeds for an extended period of time

12. Typical Terms and Conditions (1/2)
Coverage is for financial losses resulting from a breach of a R&W
Separate from other transactional liability insurance (e.g., tax position insurance and known contingent liabilities)
Policy can cover all R&W, including general, fundamental and tax R&W
Certain R&W (e.g., environmental) may require additional diligence by the insurer and can affect the premium
Typical exclusions include fines, penalties and taxes (even if included in contract definition of damages); terrorism, war, etc.; and pollution
Consequential and multiplied damages: follow silence with silence
Can provide for longer survival period than in the purchase agreement
Coverage is 3 years for general R&W and 6 years for fundamental and tax R&W
If there is a particular R&W (e.g., IP) that a Buyer wants to convert to a fundamental R&W, that can be covered by the policy as well

13. Typical Terms and Conditions (2/2)
Insurers generally want both parties to retain some risk, though "no Seller indemnity" policies are possible
Typical retention amount is 1-2% of transaction value
Risk sharing as between Buyer and Seller for this retention amount can be subject of negotiation, but insurers will often want the Seller to retain some of this risk.
Policies typically cost 3-4% of the covered amount inclusive of an underwriting fee paid at the time underwriting commences to cover diligence and document preparation costs
Spreads tightening over time

14. Putting a Policy in Place (1/2)
Typically purchased by the Buyer (even if required by a Seller) but costs are often shared between Buyer and Seller (via a purchase price reduction)
Insurance broker assists with obtaining initial quotes, underwriter selection and process management as well as policy negotiation
Initial quoting
Sell-side marketing materials (e.g., Management Presentation), audited financials (if available) and draft transaction documents serve as the basis for quotes
Quotes generally obtained within 3 days

15. Putting a Policy in Place (2/2)
Underwriter diligence
Typically lasts 3-5 days and primarily consists of review of diligence performed by Buyer and its advisors (on a non-reliance basis)
Diligence process culminates in an underwriter call with Buyer and its advisors to walk through any outstanding questions/issues the underwriter may have
Policy negotiation and execution
Typically signed concurrently with execution of purchase agreement to avoid no gaps in coverage
For transactions with delayed closings, coverage may incept at signing providing coverage for breaches of the signing R&W discovered after signing, as well as breaches of the closing R&W discovered after closing (but excluding breaches that both arise and are discovered in the interim period)

16. Post-Closing Claims
Post-closing claims submitted to the insurer but can work with broker to assist with submission
Insurer behavior reflects competitive market
Post-closing claims submitted similar to other insurance claims
Initial indications from policies in recent years suggest claims and recovery rates comparable to traditional indemnity arrangements

17. R&W Insurance as tactical tool03
R&W Insurance as tactical tool

18. Tactical Value to Strategic Buyers
Sellers sometimes will mandate a Buyer use R&W insurance
“no indemnity, no escrow”
Tool to differentiate your bid
Improve your perceived net price without raising headline offer price
Can be particularly useful when prices in a competitive auction expected to be similar
Speed is life - a Buyer using R&W insurance can be ready to execute quickly
Offer certainty of value to a seller
Address shorter survival periods and lower caps by insuring up to more market levels

19. Tactical Value to Strategic Buyers
Improve overall indemnification profile
Opportunities to increase amount (higher cap), lengthen time period and broaden scope, relative to what a seller would agree
Improve counterparty credit profile
Replace founders or shell companies with investment grade insurance company

20. Illustrative Buy-Side Implementation
Buyer Introduces First
Seller
Buyer 3
(uses R&W Solution)
Buyer 1
(requires
escrow / indemnity)
Wins Auction
Buyer 2
Buyer 4
Buyer 5
If a single buyer in an auction process is the first, and only, potential buyer to introduce the concept it can accomplish the following:
Shut down the auction early as the buyer can accept the seller’s reps as is, knowing insurance is in place
Arbitrage the cost of insurance against the seller’s desire for a clean exit
Achieve a lower up-front purchase price in exchange for Seller obtaining a cleaner exit
Or, if you are Buyer 1, prepare to adapt quickly so as not to lose out to Buyer 3

21. Pros for Strategic Sellers
A tool to help facilitate a clean exit
Helps to get bidders to the best and final bids
Quality of bids may not be impaired as insurance policy may result in equivalent or better coverage than would have been a result of negotiations
Allows a Seller to maximize cash proceeds and minimize post-closing indemnity risk
Mitigates risk of protracted claims by aggressive Buyers

22. Illustrative Sell-Side Implementation
Seller Introduces First
Seller
(introduces no/limited indemnity)
Buyer 3
Buyer 1
Buyer 2
Buyer 4
Buyer 5
When Seller introduces the no/limited indemnity concept as part of an auction process to multiple buyers, the Seller can potentially mitigate any “discount” that a Buyer hopes to achieve by preemptively doing so, and also ensure a cleaner exit
Improve comparability of bids

23. Hurdles to Utilization by Corporates
Unfamiliar terrain for lawyers and commercial teams
Can be a change from a company's approach to making (or defending) claims
Counterparty risk/balance sheet issues less frequently a concern in transactions involving only strategic parties
Time pressure may differ in some negotiations between strategic parties

24. 04
Conclusions and Q&A

25. What next? More insurers entering a formerly limited marketplace
Substantially more insurance capital available to facilitate using R&W Insurance in more and larger transactions
Process streamlined such that obtaining R&W Insurance should not slow down a transaction, and may even help get to closing faster
More parties are proactively using R&W Insurance as a tool
Not just circumstances where a PE Seller mandates it
Strategic sellers can use to obtain a clean exit
Buyers using proactively to differentiate a bid
Watch for Buyer recovery rates on claims
Insurers touting how much they are paying out in claims - but how does that compare with historical recovery rates for buyers making claims?

26. Today's Presenters John Ivascu Jim Marshall Matthew Wiener
Vice President, Associate General Counsel and Assistant Corporate Secretary | Forum Energy Technologies, Inc.
John Ivascu serves as Vice President, Associate General Counsel and Assistant Corporate Secretary of Forum Energy Technologies, a Houston, Texas based global oilfield products company, serving the drilling, subsea, completions, production and infrastructure sectors of the oil and natural gas industry. Prior to joining Forum, Mr. Ivascu practiced corporate finance, mergers and acquisitions, and securities law with Vinson & Elkins L.L.P. in New York and Houston. Mr. Ivascu began his career prosecuting accounting fraud, insider trading, market manipulation, and market timing matters for the U.S. Securities & Exchange Commission’s Division of Enforcement in New York.
Jim Marshall
Partner | Baker Botts L.L.P. | |
Jim Marshall represents public and private companies, primarily in the energy sector, in a broad range of corporate and securities matters. Mr. Marshall advises companies in connection with takeovers, including representing both bidders and targets in connection with several high-profile contested transactions, as well as private sales and acquisitions, joint ventures and strategic alliances, many of which involve seeking creative solutions to complex cross-border issues. He also represents issuers and investment banking firms in connection with equity and debt capital markets transactions and counsels companies general corporate governance matters and U.S. public company reporting requirements.
Matthew Wiener
Senior Vice President | AON Transaction Solutions | |
Matthew Wiener joined the Aon Transaction Solutions Team as the head of its Southwest Region. Prior to joining the ATS Team, Mr. Wiener was a senior associate at Vinson & Elkins LLP, where he specialized in corporate finance and securities law matters, including mergers and acquisitions, private equity, public and private securities offerings, divestitures, and general corporate representation. His practice included representation of a variety of public and private companies, as well as private equity funds and investment banks, with a significant focus in the energy sector.