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Law for Business

Knowhow - guidance - precedents

07 MAY 2013

Warranty and Indemnity and Transactional Liability Insurance

A powerful tool, not just another insurance policy!!

Warranty and Indemnity and Transactional Liability Insurance are general terminology used with regards to any insurance products designed to assist companies in resolving contingent liability issues they may have. These can be either current issues they have or potential issues they face, when looking to acquire or dispose of assets. The purpose of the product is to, where possible, wrap the problem in a policy that eliminates, or minimises, the impact of whatever the contingent risk is. The scope of coverage is determined by the issues that are being considered. Therefore, each policy is bespoke so that it address's the issues and wraps them with insurance. Below are examples of insurance solutions. This gives you some insight as to how this product can be used. However, its use is as creative as you want to make it.

Representations and Warranties Wrap - Buyer policy

In the Sale and Purchase Agreement, various representations and warranties are made to support the documents and value of the business being sold. Detailed due diligence is carried out by both parties to ensure that the buyer has full knowledge and detailed disclosure of the business and risks. The buyer is relying on statements made by individuals of the selling company, having to, in many instances, rely on those statements without necessarily being able to validate them with a third party. Therefore, there is an element of trust that the buyer is relying on.

Once the transaction has closed and the seller receives funds from the buyer, there could be a period of time where some of those funds are placed into an "escrow account". This typically could be for a period of between 18 months to 2 years depending on what had been negotiated, prior to the sale. However, it could be longer. The purpose of the escrow is to enable the buyer to "claw-back" any amounts which they are entitled to as a result of the non-performance of a representation or warranty. The amount of the escrow would have been negotiated prior to closure. Once the agreed time period is up, the escrow is released to the seller unless there are outstanding payments to be made. Therefore, once the escrow is no longer available to the buyer, their ability to "claw-back" any monies from the seller becomes more difficult, for obvious reasons. Equally, in the event that the escrow, whilst in place, does not have the adequate funds to cover the financial loss sustained by the buyer as a result of the non-performance of a representation or warranty , again it could be very difficult for the buyer to "clawback" that shortfall of the loss they sustained.

The purpose of the Representations and Warranties Wrap is to eliminate such uncertainties for the buyer. Its purpose is to provide the buyer with reimbursement for such financial loss, after the closing of a deal. It gives the buyer certainty that in the event any of those representations or warranties they have relied upon, when agreeing on a purchase price, are not correct or even fraudulent, on the basis the loss has not been specifically excluded with the policy language, the policy will respond.

Representations and Warranties Wrap - Seller policy

As has been referred to in the above, there will obviously be a seller in the process. Many sellers wish to ensure that the funds they receive from the sale of the business are secure. Having provided the representations and warranties in good faith, they do not wish that, in the event such a representation or warranty was not to perform, over and above the escrow, they have to hand back some of the funds as "claw back". Any coverage for fraudulent acts committed by the seller, would be excluded, but all other acts, other than those specifically excluded, would be covered.

Escrow Eliminator Wrap - Buyer product

The purpose of this product is to provide our clients with a competitive advantage when looking at acquisitions. With this product the buyer is able to offer a more attractive bid to a seller by enabling the seller to reduce the Escrow required. For whatever reasons, a seller may have put a significant escrow amount on the table to attract more buyers to create a more competitive bidding process. The purpose of this product is that it enables our clients to put a bid offer on the table which doesn't require the seller to offer such a high escrow amount. This clearly has significant benefits as means the seller is able to walk away once the business is sold, with more funds at the outset. They are able to reduce the money in an escrow, which means they can use those funds immediately, rather than have them sitting in an escrow account, generating a very low return.

Tax Wrap

During the due diligence (DD) process, the tax DD may have highlighted a differential in the potential for additional tax to be paid. This would be as a result of applying a different test by the tax authority when calculating the applicable tax owed. The tax DD may have highlighted that, in the event of such different test being applied, the amount of tax payable may be greater than that which has been accounted for in the balance

sheet. This product is not designed to pick up tax avoidance or evasion, but the differential that is discovered at a later stage, where there was a shortfall in the tax owed. The value of this product is when the sale/purchase of a company is being negotiated. The tax DD report is often used by the purchaser as a "chipping" tool. Equally, the potential amount that the DD report has highlighted, may become a deal breaker, as neither party can come to an agreement on how they are prepared/able to resolve incorporation of the potential problem in the sale and purchase agreement. The Tax Wrap policy would resolve these by covering the difference between the tax, which has already been accounted for in the final accounts, and the amount which the Tax DD report has highlighted. Therefore, in the event the tax authority was successful in their challenge, the policy would step in to fund the amount required.

Ransom Wrap

A company is looking to sell, however, the sale is being frustrated because a third party is holding the Seller to ransom over an issue and by doing so, has created some uncertainty as to the liabilities and value of the business/validity of ownership, or they are using the threat of litigation, which could be protracted and the outcome uncertain. Consequently, the Seller must disclose this to the Buyer and as a consequence, could stall or scupper the sale. This is not an uncommon situation companies find themselves in, as it clearly is the time when an aggrieved third party has the upper hand and if they are aware of this, will inevitably exploit the opportunity. They have everything to gain from frustrating the sale and know that the Seller will wish to resolve the issues swiftly, in order to close the deal. Therefore, the purpose of the Ransom Wrap is to eliminate this issue for the seller by ring-fencing the issue, wrapping the liability and costs so that, the seller can continue to dispose of the business and disclose to the buyer that the issue is ring-fenced by an insurance policy which will take all of the

litigation costs and settlement. In the event the party disputing is successful, the policy would settle the disputed amount that was being demanded, (assuming adequate limits of indemnity had been purchased), thereby ensuring that the buyer would  not be financially "out of pocket".

Residual Liability Wrap

Private Investment Fund ("PIF") X has completed its investment programme and all the portfolio investments have been sold. In connection with the sale of one of its portfolio companies, the fund retained the obligation to indemnify the buyer for certain contingent liabilities that the buyer of that company was unwilling to assume. While the probability of the indemnification obligation being called upon is quite low, the fund manager is required to reserve for the full amount of the indemnification obligation, until the obligation expired, which was seven years. Consequently the fund was not able to make a full and final distribution to the original investors. We were able to structure a policy which wrapped the indemnification obligation for the full period and limit. Consequently, the funds could be distributed in full. This policy can be obtained at any point in time. So, if you have such obligations which have been running for some years, but still have unexpired time, we can look to wrap the remaining period.

For further information, please contact:

Neo Combarro

Tel: +44 (0)20 7933 2123

Ray Pallett

Tel: +44 (0)20 7933 2770

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