While M&A activity remains robust, there are rumbles in the market that a softening of that activity may be on the horizon with growing indications of a misalignment of price expectations between sellers and buyers resulting in longer negotiations.
With the current volatility in the markets and high-profile collapses in the construction industry indicating signs of distress in the economy, our insolvency partner Nick Edwards is of the view that there will be an increase in distress and formal insolvencies later this year, which will continue over the course of 2023.
While buyers with cash and liquidity may see opportunities in this market, one of the key challenges that buyers in distressed or insolvent transactions face are the limited warranties and indemnities that sellers are willing to (or are able to) provide, resulting in a gap between the sellers’ and buyers’ appetite for liability and risk.
Our M&A partner Jo Ruitenberg spoke with Geoffrey Lee, Regional Manager, Asia Pacific for Liberty Global Transaction Solutions, for his views, from an insurer’s perspective, on the appetite to provide W&I insurance as a means of bridging the gap between sellers and buyers in distressed transactions.
- What is the appetite for providing W&I insurance in distressed transactions? Like all transactions, distressed or not, the availability of insurance depends on the particular transaction and industry. In a distressed transaction, insurers will be particularly focused on the level of due diligence undertaken by the buyer and disclosures by the sellers and the extent that management has been involved in providing those disclosures.
- Can Synthetic W&I insurance bridge the gap? While this product has been utilised overseas, it is not common in Australia and there may be structural considerations to take into account. Synthetic W&I insurance cover warranties that are provided in the W&I policy itself and are separated from the SPA regime so that there is no actual warrantor. Given that one of the key functions of warranties is to draw out disclosures from the sellers, it may be problematic that the warranties are provided outside of the SPA regime.
- What are the top 2 issues that you see in buyers seeking W&I insurance? Firstly, payroll/award compliance due diligence and payroll sampling remains an area of particular focus. Secondly, the W&I insurance market continues to be stretched from a capacity perspective which impacts timing and availability of the insurance. Parties should allow sufficient time to go through the underwriting process.
Key features and challenges
To increase your chances of obtaining W&I insurance in distressed transactions, parties should note the following:
- Target as the warrantor: Insurers may provide W&I insurance in the distressed context with a policy in which the target is the warrantor with a carve out for fraud of the warrantor given the insurer’s inability to subrogate against the owners of the target. This is similar to the coverage provided for public M&A transactions rather than the more common private M&A transactions where the seller is the warrantor.
- Buyer’s due diligence: With sellers often pushing to limit the due diligence process to complete the sale quickly and avoid any further slippage in trading conditions, buyers often take a more commercial view on what particular areas should be targeted in the due diligence. This needs to be balanced against the insurer’s requirement that appropriate due diligence is undertaken. It is likely that solvency warranties would be excluded in an insolvent transaction, and the extent and scope of financial warranties would be looked at carefully given the target has struggled financially. Engaging with brokers early in the process can give you a steer towards the areas that insurers will likely focus on given the particular industry and/or assets and the potential coverage of specific warranties.
- Disclosure against the warranties: Insurers will be focused on the level of disclosure provided to the buyer and the level of involvement of management in providing those disclosures. It is important that the people who know about the business and are involved in its operations have considered the warranties and been involved in disclosing against those warranties (even if they are not the ones giving the warranties).
For other Hamilton Locke articles on distressed M&A: Distressed M&A – what you need to know