Using Synthetic Warranties to De-risk During Insolvency
In Mergers & Acquisitions (M&A), buyers face the risk of the financial, legal and operational positions of the target entity deviating from what is expected, and typically seek warranties from the sellers to manage that risk. If a warranty is untrue, and the buyer suffers financial loss as a result, reimbursement is typically sought from the sellers.
In an insolvency scenario, the situation is markedly different. In most cases, when a business is sold out of voluntary administration it is sold in an ‘as is’ condition. Administrators, who have run the company for only a short time, are rarely in a position to provide accurate warranties. Further, there is little appetite for an administrator to assume personal liability related to the giving of warranties.
This results in negative outcomes for both buyers and administrators in insolvency scenarios. When a company is sold ‘as is’, buyers are left vulnerable with little means of protecting the purchase price. This can result in buyers approaching pricing conservatively, which runs counter to the administrator’s duty to maximise value for stakeholders.
Warranties and indemnities insurance (W&I) with “synthetic warranties” is a means of providing buyers with meaningful warranty protection without subjecting administrators to any additional liability.
In a traditional W&I scenario, the warrantors would give a robust set of title, operational and tax warranties, and the sale and purchase agreement would establish that the sole recourse in the event of a warranty breach would be against the W&I insurer, except in the instance of fraud by a warrantor. The W&I insurer would then retain a narrow right to subrogate against a warrantor, essentially directly claim against, in the event that a claim was paid to the buyer and that claim arose from the fraudulent activity of a warrantor.
Through the use of Synthetic W&I coverage, Marsh is able to procure W&I coverage for a buyer without possibility of the administrator being claimed against. With Synthetic W&I coverage, warranties are not given in the sale and purchase agreement. Rather, the set of warranties is appended to the policy itself and so there is no potential liability deriving from the giving of the warranties in the sale document.
Either administrators or buyers initiate this solution. Administrators are using Synthetic W&I as a stapled solution in order to help themselves to maximise purchase price. Buyers in insolvency deals which do not have stapled W&I are seeking the coverage so that they can obtain standard warranty protection for operational, title and tax matters.
Procuring Synthetic W&I Coverage
To procure Synthetic W&I coverage, the first step is to approach a Marsh Transactional Risk team member. We can procure non-binding indications from W&I insurers once we are provided the sale and purchase agreement, an information memorandum (or similar) on the target, and the proposed set of warranties to be insured. We recommend that these warranties represent a reasonable middle of the road position, and that the parties on the target side engage in a standard disclosure process including a well populated data room. Buyers should conduct commercially reasonable diligence to confirm the accuracy of the synthetic warranties to be included in the policy.
Restructuring and Turnaround Lifecycle
Many businesses will be impacted by other issues that emerge from the restructuring and turnaround lifecycle. To support impacted stakeholders, Marsh and Mercer have joined forces to create a dedicated taskforce of M&A, insurance and people risk specialists to assist companies, directors, private equity funds, insolvency practitioners, lawyers and other advisors. We can help you manage the unique set of risks and costs arising from the COVID-19 pandemic throughout each phase of the Restructuring and Turnaround Lifecycle.
If your business is in financial distress or going through voluntary/formal administration or receivership, we are here to help. Conversely, if your business is on the road to recovery, we can also help you thrive and succeed.
We recently published a paper, which you might find useful: De-Risking the Distressed: Risk & People Solutions for Distressed Companies. To learn more about the various solutions available to de-risk during these uncertain times download our paper now.