Insights

Special Purpose Acquisition Companies (SPACs) are formed for purposes of merging with or acquiring companies. SPACs raise capital through an initial public offering, then typically have eighteen to twenty-four months to invest capital in a target company or companies.  A SPAC’s merger with the target company is referred to as the de-SPAC transaction. Although SPACs have existed for many years, they have gained popularity over the last few years and 2020 has already surpassed previous SPAC fund-raising records.

An emerging trend in de-SPAC transactions is the increased utilization of M&A insurance.  Although some SPAC managers are embracing the use of M&A insurance, M&A insurance is not used as frequently on de-SPAC transactions as it is on private, buy-out transactions.  In the following sections we outline the benefits to using M&A insurance on de-SPAC transactions and dispel myths that have dissuaded SPACs from using M&A insurance in the past.  M&A insurance refers to the following insurance solutions:

• Representations and Warranties (R&W) insurance. R&W insurance provides the insured party with protection against losses arising out of breaches of the representations and warranties that are given by seller and target in the transaction agreement.  R&W insurance reduces or eliminates the need for a traditional seller indemnity, as buyer receives comparable contractual protection from an A-rated insurance company.
• Tax insurance. Tax insurance provides financial protection against the failure of an investment or a tax position to qualify for its expected tax treatment. Tax insurance is frequently used on M&A transactions to ‘ring-fence’ potential tax liabilities at a target company.
• Contingent liability insurance. Contingent liability insurance is a highly bespoke solution that can be used in a wide range of situations to isolate potential losses that may arise from known risks that are remote but could result in significant loss.

There are various benefits to buyers and sellers in using M&A insurance, but the following are particularly relevant for SPACs:

• Key relationship preservation. Management at the target company will usually continue to manage the merged company following the de-SPAC transaction, and the target’s existing shareholders will usually retain equity following closing. By utilizing M&A insurance, the buyer can bring a claim directly against an insurer rather than needing to initiate a potentially adversarial and distracting process with management or the sellers.
• Protection for the SPAC’s directors and officers from shareholder lawsuits. Directors and officers at publicly traded companies are vulnerable to lawsuits from investors and SPACs are no exceptions.  Shareholder lawsuits may be brought following the de-SPAC transaction if the target incurs unforeseen liability or other types of damages are suffered.  M&A insurance reduces the risk of shareholder claims as the company and, indirectly, the shareholders will be indemnified for losses that arise out of a breach of a representation and warranty or a tax or contingent liability issue that were covered.

• Competitive pressure. SPACs are often competing for attractive target companies, either in an auction process or against the alternative offered by a private sale. The competition – private equity firms and corporates – are generally comfortable using M&A insurance and offering sellers a clean exit on the transaction.  If a SPAC is unwilling to use M&A insurance their offer will be viewed as less competitive and it may need to increase its purchase price to compete with alternative sale options that sellers may have.  The target company of a SPAC may also be considering going public through an initial public offering or a direct listing, as opposed to a reverse-merger with a SPAC.  These alternative paths to going public will not require the target’s shareholders to provide a post-closing indemnity or tie up funds in escrow, so a reverse-merger with a SPAC may appear less attractive if the SPAC is seeking a seller indemnity.  M&A insurance provides the SPAC with post-closing protection all while staying competitive with the alternative exit options of target’s shareholders.

Buyers and sellers on all M&A transactions should assess whether using M&A insurance for their transaction is appropriate.  Concerns around timing, cost, confidentiality and claims may have dissuaded SPACs from using M&A insurance in the past, but addressing misconceptions about these subjects should provide all stakeholders involved in de-SPAC transactions with the comfort to pursue M&A insurance:

• Timing. The M&A insurance market is accustomed to working on ‘deal timing’.  The first step of the insurance procurement process involves having your broker solicit quotes, and this can be completed in 2-3 business days. The second (and final) phase of the process requires the buyer to engage an insurer to start underwriting and complete the underwriting process.  The underwriting process is typically completed in 5 business days, but it can be compressed to accommodate faster deal timelines.
• Cost.  SPACs generally must operate within a reasonable budget and not incur unnecessary and irrecoverable costs before the closing of the de-SPAC transaction.  An M&A insurance policy can be explored and ultimately bound with minimal capital requirements.  There is no cost to obtaining quotes so the SPAC can get visibility into what can be covered and other policy terms without committing to any fees.  To start the second phase of the process the SPAC will be obligated to pay the insurer’s underwriting fee.  This fee is typically $25k-$40k, but insurers are often willing to defer payment until closing.  The other pre-closing cost component under a usual M&A insurance policy placement is the deposit premium, which is typically 10% of the premium and becomes payable when coverage is bound at signing.  McGill and Partners can structure a solution, however, for SPAC transactions whereby the 10% premium deposit does not need to be paid at signing, nor would the SPAC be obligated to pay a break fee if the transaction does not close.  In other words, coverage can be fully underwritten and bound at signing, and the SPAC would only need to commit to a nominal ($25k-$40k) underwriting fee, with all other expenses only becoming payable upon closing.
• Confidentiality.  There are many reasons why M&A transactions must remain confidential until they are announced publicly, and this is especially true for SPACs.  The M&A insurance market is staffed with M&A professionals that understand the importance of confidentiality and the potentially irreparable harm that can come from leaks.  Many of the largest and most sensitive transactions that have taken place in recent years have successfully used M&A insurance. Further, it is common practice for confidentiality agreements to be put in place with the insurance broker and all insurance carriers before any confidential information is shared.
• Claims.  An insurance policy is only valuable if it will pay out when the policyholder suffers a loss.  The M&A insurance market has demonstrated in recent years that it will respond to valid claims, with approximately 95% of claims being paid according to recent survey respondents (Lowenstein Sandler, 2020).  At McGill and Partners our dedicated M&A claims team, which has unique insight from professionals that have been involved in claims while employed by insurers, works with our clients to ensure claims are being presented to insurers in the most effective way possible and advises our clients on negotiation and resolution strategies.

McGill and Partners is a boutique insurance broker focused on exceptional client service and superior results.  Our decades of global experience combined with legal and investment banking backgrounds enable us to deliver market defining risk solutions.  We have structured M&A insurance across the M&A spectrum including buy-outs, corporate acquisitions, minority investments, carve-outs, take-privates, fund restructurings, de-SPAC transactions and GP-led secondaries transactions. Additionally, we have placed M&A insurance across industry verticals that are common targets for SPACs, including technology companies throughout the growth lifecycle, as well as life science and pharmaceutical companies, allowing us to advise our clients on diligence focuses for underwriters and other coverage enhancements. With our experience, creativity and tenacity, we help clients embrace acquisition opportunities with confidence.

The bolder your ambition, the better we become

If you would like more information, please contact:

Jeff Buzen | jeff.buzen@mcgillpartners.com

James Swan | james.swan@mcgillpartners.com

Charles Inglis | charles.inglis@mcgillpartners.com

Sam Murray | sam.murray@mcgillpartners.com

Edward Ring | edward.ring@mcgillpartners.com

Abheek Dutta | abheek.dutta@mcgillpartners.com

Economic crisis will not be a new experience for most companies and financial sponsors. Recent downturns have presented their own unique challenges. The speed and shock of the COVID-19 crisis has allowed little time to plan. With countries accounting for over 50% of the world GDP in lockdown and house-hold brands already filing for administration, McGill and Partners has been analysing how the M&A environment will be different once deal activity resumes. 

While the crisis has, understandably, relegated M&A as an immediate priority, the volatility that has caused financial difficulties for many may soon present an upside for those looking to acquire or invest in companies that were previously off the market and now in need of capital. Corporates looking to sell non-core assets to bolster cash reserves to weather the storm or indebted sellers looking to reduce debt burdens present some of the many attractive opportunities for buyers / investors in this downturn. 

At McGill and Partners, we have been advising clients on using warranty and indemnity insurance to de-risk liabilities acquired when buying or investing in distressed situations. There are many characteristics of a distressed sale process that impose limitations or present challenges; careful thought and planning are required to navigate them. Here are some of the considerations you may wish to give thought to if you are looking to obtain M&A insurance protection for your distressed transaction. 

Insurance solutions using synthetic warranties 

While a buyer can take advantage of a distressed situation to acquire a high-quality target at a lower price, it will often not be afforded the same contractual protections that it might otherwise receive in a non-distressed, private M&A transaction. Sometimes it may not be possible for a buyer to negotiate a meaningful set of warranties because the seller is unwilling or unable to give them (for example, if the seller or management team’s equity is underwater or will result in negligible proceeds or perhaps, in the case of an insolvency practitioner, reflecting the limitations on his or her ability to disclose against the warranties because he or she has not been involved in the historic management of the business). In each case, the seller is looking to achieve a sale for the best possible price while limiting their liability. In such scenarios, it may be possible to structure an insurance solution where a synthetic set of warranties is included within a W&I insurance policy that would give the buyer protection if a warranty is breached. The warranties are deemed to be synthetic as they are not given by the seller in the transaction documents but instead are negotiated between the buyer and the insurer and included solely in the W&I insurance policy. 

For these types of policies, careful consideration needs to be afforded to the drafting and breadth of the warranties given by the insurer. Unlike a typical private M&A process, a buyer’s access to management teams and the level of diligence they can practicably conduct may be significantly restricted in a distressed sale process. Accordingly, the suite of warranties an insurer would be willing to cover may be more limited to reflect the matters that could reasonably be the subject of diligence by a buyer and its advisers with minimal engagement from the seller or management. 

In addition to reviewing the diligence the buyer has already conducted, the insurer will prepare a targeted Q&A focussed around the scoping of the warranties in order to elicit information from the seller to give them comfort to provide cover. The collaboration between the buyer, seller / management and insurer during this broker-facilitated process is of importance in determining the breadth of warranty protection, as the insurer seeks to align the scoping of the warranties with the buyer’s due diligence and responses to its Q&A. Ensuring the insurer is comfortable with the quality of the diligence exercise and disclosure process is of particular importance as the insurer does not have a traditional right of subrogation against the seller in the event of fraudulent non-disclosure since the seller is not giving the warranties under the transaction documents. For these reasons, it is necessary to engage with the insurance workstream as early as possible to allow the insurer to provide direction on the buyer’s diligence scope to achieve a set of warranties that is sufficiently broad to suit the buyer’s aims. 

Valuation and loss recovery 

Maximising the proceeds from a sale is important irrespective of the nature of the sale, particularly where a seller urgently requires an injection of capital. Though for some distressed transactions, pressure from creditors, maturing debt and falling levels of liquidity (amongst other factors) might drive a sale that sees a trade-off between maximum return and speed of execution. Irrespective of whether the seller is willing to give warranties, or an insurer structures a synthetic policy, if warranty insurance protection is sought buyers should give particular attention to the target’s valuation and how this interacts with the quantification of loss that would be recoverable under the policy. 

As recently reaffirmed by the High Court,[1] the correct measure of damages when quantifying loss for a breach of warranty in the relevant transaction document is the diminution in the value of the purchased shares, such diminution calculated by reference to the actual value of the target deducted from its market value had the breached warranty been true. While the courts will often look to the purchase price to determine the “market” value,[2] if expert evidence supports the conclusion that the company was sold at an undervalue (or indeed an overvalue) then the court will take this into account when determining the fair market value of the company and, therefore, the diminution in the value of the shares arising from the breach of warranty. 

This approach was recently applied by the courts,[3] with the judge citing both the speed at which the sale was executed and the sellers’ desire to sell the company in the immediate future as factors contributing to their conclusion that the company was sold at an undervalue. It was also found that, had the sellers’ contractual cap on liability in the relevant transaction document not been limited to the purchase price, the total damages awarded would have been in excess of the purchase price. 

Buyers should carefully consider the policy drafting to ensure the loss they would be able to recover aligns with their expectations, having regard to the target’s valuation. This is of particular importance where distressed targets are being acquired for a nominal value and buyers will need to give thought to the valuation methodologies applied, as these are likely to form an important focus of an underwriter’s review. 

It is also common in distressed sales for management to be given equity in the new target structure, which sometimes may be disproportionately higher than a non-distressed transaction. Where the rolling management team acts as warrantors, insurers take caution that a valid claim against the policy may result in management indirectly benefiting from their own breach of warranty. Depending on the percentage equity the rolling management take in the target group, consideration should be given to the loss insurers are willing to indemnify both in terms of the proportion of loss and nature of the breach of warranty; for example, some insurers might only pay claims proportionate to the insured’s equity interest in the target group or may limit the portion that may be recovered for a fraudulent breach. 

Minority investments 

Businesses in financial difficulty looking for an injection of capital or those with healthy balance sheets looking for capital to be used to acquire struggling businesses to accelerate growth may present attractive opportunities for third-party investors to obtain a minority interest in companies at an attractive valuation or that might otherwise not have been seeking financial sponsorship. For these investments, minority investors may seek warranty protection from the target company or its management, but the reality of the commercial relationship between the investor and the warrantor(s) may make claiming against them impracticable (indeed, warrantors may cap their contractual liability at a nominal amount from the outset). Warranty and indemnity insurance is commonly used by investors in these scenarios to provide them with protection for a breach of the warranties they have been given. However, the practicalities of a minority investment will inform the structure of, and approach to, the insurance policy. 

Following a claim, insurers will typically require access to certain information in order to properly assess the merits or quantum of a claim or require the insured to take or omit to take certain actions (e.g. to mitigate losses). Similarly, insurers will expect, usually at their own expense, to be entitled to fully participate in the defence, negotiation and settlement of third-party claims and, in particular, require the insured not to settle or compromise any third-party claims without the insurer’s prior written consent. In each case, a material failure to comply with these policy requirements is likely to prejudice the insured’s rights of recovery. Policyholders need to ensure that the drafting of these provisions has regard to the minority investor’s influence and reflect the contractual rights (either to information or participation) that the minority investor has to facilitate the insurer’s involvement in the claim. 

As is commonplace in a warranty and indemnity insurance policy, insurers will waive all rights of subrogation against the warrantor save in the case of fraud. Dependent on the investment structure and level at which a minority investor invests, and assuming a target company gives the warranties, if the investor has a direct or indirect financial interest in that entity (e.g. because the vehicle through which the investment is made becomes the parent entity), the insurer’s subrogation rights need to be more closely considered. While the insurer agrees to indemnify the investor for an insured loss, if that loss arose from a warrantor’s fraudulent breach of warranty the insurer’s rights of subrogation could permit recovery of the loss amount from the warrantor. Thus, the investor’s financial interest in the warrantor would indirectly cause them to suffer a financial loss at a subsidiary level. Investors should make sure that insurers narrow their subrogation rights further to limit this application. 

The bolder your ambition, the better we become 

Combining true expertise with a fresh perspective to deliver market defining risk solutions, our experienced M&A team is committed to helping clients to navigate the current uncertainty and to capitalise on the opportunities presented. There are many other creative bespoke solutions our M&A team has developed to address deal issues, each tailored to the situation and the needs and objectives of the client.

If you would like more information on the solutions outlined, or to find out if we can use our expertise and creativity to help you to resolve any other deal issue, please contact edward.ring@mcgillpartners.com or another member of the M&A team: 

James Swan | james.swan@mcgillpartners.com 

Charles Inglis | charles.inglis@mcgillpartners.com 

Sam Murray | sam.murray@mcgillpartners.com 

Abheek Dutta | abheek.dutta@mcgillpartners.com 

_____

[1] Oversea-Chinese Banking Corp Ltd v ING Bank NV (2019). 
[2] See Triumph Controls UK Ltd & Anor v Primus International Holding Co & Ors (2019). 
[3] Cardamon Ltd v Macalister & Anor (2019). 

2020 began with renewed optimism for cross-border deal making, with growing consensus that geo-political threats were subsiding and the business world was moving into a period of increased certainty. Unfortunately, few predicted the speed at which the Covid-19 pandemic would consume the world and the rapid change it would bring. The exit paths from lockdown will be precarious and the new environment will have to be mastered. 

Opportunity for dealmakers has not disappeared. US buyers have always looked to Europe for investment options at all stages of the financial cycle. At McGill and Partners, we are acutely aware that financial sponsors’ primary focus will understandably be their existing portfolio companies, but with $2.5 trillion of dry powder at their disposal (Bain & Company, 2020) attention will turn to investment opportunities. Times of uncertainty beget a desire for familiarity. US clients may increasingly elect to structure European acquisitions in the US format and the M&A insurance market is ready to respond. 

Characteristics of a US deal structure are commonly viewed as more buyer-friendly, which is usually reflected in the breadth of M&A insurance coverage. These include the disclosure obligations of the sellers and the transfer of economic risk to the buyer at closing rather than at signing. If a buyer is focused on structuring a US-style deal in Europe, then it is possible to obtain a M&A insurance solution that is akin to US Representation & Warranty (R&W) insurance. 

Examples of the practical effects can be spilt into two categories: (1) technical coverage; and (2) underwriting style. Technical coverage includes a number of points, one of the more fundamental being the differences in disclosure regime. It is standard on European transactions for the data room to be deemed generally disclosed in the transaction agreement and the R&W policy. This is not the case in the US; the data room is not deemed disclosed in the transaction agreement or the R&W policy and instead specific disclosure schedules are prepared. If buyers are able to adopt a US-style disclosure regime in the transaction agreement on a European deal, the M&A insurance can follow suit. If the parties cannot agree to a US-style approach to disclosure, in certain circumstances an artificial approach using insurance may be possible. 

Underwriting style is unique to each insurance carrier, but fundamental differences exist between the approaches taken in the US and in Europe. As an example, the requirement to provide written responses ahead of an underwriting call is not commonplace in the US and should not be required on a US-style deal. 

Why is this important now? As we emerge from the crisis and dealmakers begin looking for opportunities, many anticipate a shift in M&A leverage from sellers to buyers, which in turn may allow US buyers to initiate and dictate US-style deal terms. Previously, European sellers have often been able to resist the preparation of US style disclosure schedules, but they may now have to reconsider if US buyers are offering attractive deal terms. The strength of the dollar relative to European currencies may also increase the buying power of US investors in Europe. The ability to achieve true US-style M&A insurance coverage in Europe will allow US buyers to use insurance to gain comfort with a level of protection that is more familiar, allowing them to pursue investment opportunities with confidence. 

At McGill and Partners, we are implementing our unparalleled cross-border insurance broking and underwriting expertise in EMEA, North America and Asia-Pacific regions to help clients achieve the full potential of the insurance market. With our experience, creativity and tenacity, we help US clients to embrace acquisition opportunities with confidence. 

The bolder your ambition, the better we become 

Our decades of global experience combined with legal and investment banking backgrounds enable us to deliver market defining risk solutions. We provide a fresh, boutique perspective that helps our clients to capitalize on fast moving opportunities and obtain tailored solutions. If you would like more information, please contact charles.inglis@mcgillpartners.com or another member of the M&A team: 

James Swan | james.swan@mcgillpartners.com 

Sam Murray | sam.murray@mcgillpartners.com 

Edward Ring | edward.ring@mcgillpartners.com 

Abheek Dutta | abheek.dutta@mcgillpartners.com 

A few days ago, a high profile case brought by The Serious Fraud Office (SFO) against three senior executives of Barclays Bank charged with conspiracy to commit fraud and providing unlawful financial assistance, ended in the acquittal of all three defendants. The case followed the SFO’s failed attempt to bring a criminal case against Barclays itself based on the same events. The SFO has also failed to secure a single conviction against an individual following any of the five Deferred Prosecution Agreements (DPAs) which it has entered into with UK companies since the system was first introduced seven years ago by the Crime and Courts Act 2013. But this absence of successful prosecutions disguises an underlying reality which is that senior managers remain exposed to liability and reputational risk at a much earlier stage in the criminal process.

There is a common and understandable assumption among company directors that, provided they have not been dishonest, they will be looked after by the companies they serve. They rely on a company both to indemnify them in respect of any liabilities they many incur and to buy adequate D&O insurance on their behalf. While the interests of the director and the company coincide and provided the company remain solvent, this reliance is perfectly reasonable. It is where there is scope for divergence of interest that dangers may lurk.

Background

Since the financial crisis in 2008, there has been a relentless focus by regulators and prosecutors on the theme of personal accountability at board level. The enhanced risk of follow on prosecutions against individuals after a company has admitted a relevant offence has been recognised ever since this new weapon was first introduced into the SFO’s arsenal. The temptation on a company which has unearthed probable criminal activity to enter into a DPA can be considerable since it offers an opportunity to protect its reputation, pay a fine, limit legal defence costs and move on. Unlike in the US, there is no equivalent of a DPA for individuals in the UK (although there has been some suggestion that they may be introduced in the future). A problem associated with this disparity is that the “stay of out jail” cards which DPAs offer companies, come with a specific price tag which is “cooperation” with the SFO. This term carries a specific meaning. In Guidance on this issue with respect to DPAs the SFO state:

“Considerable weight may be given to a genuinely proactive approach adopted by P’s management team when the offending is brought to their notice….. Co-operation will include identifying relevant witnesses, disclosing their accounts and the documents shown to them. Where practicable it will involve making the witnesses available for interview when requested. It will further include providing a report in respect of any internal investigation including source documents.”

The danger for individuals

DPAs provide plenty of scope for divergence of interest between a company and its directors. In practice, in order for a company to avail itself of the considerable advantages of entering into DPAs, the “cooperation” required will extend to making available to the SFO, both oral and documentary evidence of those directors and other senior managers whom the SFO may wish to investigate. The product of the company’s own internal investigation must often also be provided on the basis that any legal privilege which the company may have over such reports is waived. The question as to whether any such individuals may later be interviewed as suspects or indeed prosecuted is almost always deferred and addressed as part of a separate investigation commenced after any DPA is agreed and sanctioned by the Court.

There is no mechanism under which the individuals potentially affected by a DPA are consulted by either party to the proposed agreement. For obvious reasons, their agreement would be unlikely to be forthcoming. That does not mean ,however, that they do not need an ability to secure access to independent legal advice and representation at an early stage. Without access to such advice it may be that unwise or incomplete answers given by them to questions raised in the context of internal company investigations are later used as evidence against them. If the decision to prosecute is taken, in a sense the directors have already lost. This is because, even if ultimately acquitted, they will have been subjected to the intense pressure of criminal proceedings and will have needed to access often very significant funds to mount their defence.

A Salutary Tale

In January 2019, a prosecution against a number of senior managers of Tesco the well-known high street U.K. food retailer for fraud and false accounting collapsed. The case concerned the restatement by the company of its financials following disclosure of the fact that there had been a £250 million overstatement of its profits in the 2013-14 accounting period. The criminal offence which the company successfully persuaded the Court to defer in relation to this restatement was an offence of false accounting contrary to s.17 of the Theft Act 1968.

The director of the SFO stated he was satisfied that there was a realistic prospect of conviction of this offence. This was based on the allegation that the U.K. finance director was personally responsible for the truth and accuracy of the financial data submitted to head office, and that both he and others “were also aware of improper recognition of commercial income” but that despite the opportunity to put things right “….they failed to take any of these opportunities and instead concealed the true position”. The company paid a fine of £129 million in respect of the offence. The judge in the subsequent criminal trial against the individuals who were supposedly guilty of this offence directed the jury to acquit on the basis that the evidence was simply too weak. 

Conclusion

Just because there have not yet been any successful DPA follow on prosecutions against individuals, this does not mean that the potential for them is not a cause for concern. Especially in the wake of the Barclays acquittals, the SFO is under intense scrutiny and will be keen pursue what it considers to be appropriate prosecutions against individuals. As the SFO put it themselves in the press release on the Barclays case:

“Our prosecution decisions are always based on the evidence that is available, and we are determined to bring perpetrators of serious financial crime to justice. Wherever our evidential and public interest tests are met, we will always endeavour to bring this before a court.”

The name of the game is to avoid being caught up in criminal proceedings in the first place. Whilst that may not always be possible, access to the right legal advice at an early stage might make a significant difference. The Barclays case took eight years to bring to trial and the SFO costs alone are estimated at £10 million. Perhaps the key take away for senior managers is that there is real value in taking personal responsibility at the time of their appointment for gaining an understanding of the triggers for and limitations of legal representation costs cover under both the company indemnity and D&O insurance policy.

The contents of this publication, current at the date of publication set out above, are for reference purposes only and set out the views of the author. They do not constitute legal advice and should not be relied upon as such. Specific advice about your particular circumstances should always be sought separately before taking any action based on this publication.