Mergers and acquisitions insurance

May 2019

We try to insure against lots of things these days—home and contents damage, public liability, negligence, and even surgery for pets. Of course, some fund managers have found professional indemnity coverage almost prohibitive in recent years and, as our feature article in this edition of Fundamental shows, insurance in the advent of the Royal Commission is likely to get harder for some industry sectors.

In the world of mergers and acquisitions, there are any number of risks and liabilities against which parties are (or should) be covered. But contractual rights only go so far. In this article, partner Langton Clarke explores some of the bespoke insurance products designed to indemnify parties in sale and purchase transactions and the cost for this protection.

Warranty and indemnity insurance

This product indemnifies parties for breaches of representations and warranties given in the sale of a company or business and can be bought by the buyer or the seller.

A buyer policy covers the buyer for losses caused by breaches of warranty given by the seller in a sale contract. It enables the buyer to claim directly from the insurer without first pursuing the seller.

A seller policy covers the seller for losses resulting from claims made by the buyer for breaches of warranty under the sale agreement.

Sellers use the insurance as a strategic tool to prevent sale proceeds being tied up in retention or escrow accounts; while buyers can use the product to increase their financial protection and certainty if recovery from the seller under a warranty claim is in doubt.

Tax indemnity insurance

When a buyer or seller involved in a merger and acquisition transaction identifies a tax exposure, then a tax indemnity policy may be considered to mitigate future financial losses should the ATO successfully challenge the underlying legal conclusion that originally formed the basis of a tax position. These policies reimburse the tax-payer for additional taxes, interest, penalties, and defence costs.

Litigation buyout insurance

This type of insurance enables a client to ringfence liabilities which may arise from any current or anticipated litigation. Having such a liability hanging over the parties' heads distracts from negotiations, so this insurance product can take away the uncertainty such a liability brings.

Cost

There is of course a cost for the protection these insurances bring:

  • For warranty and indemnity insurance, premiums are around 1 to 2.5 percent of the limit provided.
  • Taxation indemnities are understandably higher at 3 to 12 percent of the limit.
  • Litigation buyout insurance is higher again and can be up to 50 percent of the limit purchased, depending on the strength of the legal opinion in relation to the litigation.

In all cases, a robust due diligence process will be looked upon favourably by underwriters who may otherwise be reluctant to write insurance without it.

How can we help?

The incentives for taking out these types of cover may differ from party to party. However, like any insurance, it can provide protection and indemnity from specific risks and remove uncertainty in what is often already a complex transaction.

McMahon Clarke is regularly involved in corporate and business mergers and acquisitions and a member of our team can help you understand the legal implications of the various insurance options.

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