M & A Roundup: Using Deal Insurance To Smooth Negotiations

Mergers and acquisitions negotiators are making more frequent use of deal insurance to break negotiating stalemates on protection for breaches in the representations and warranties clauses in transaction contracts. “We’re seeing an increased use of deal insurance policies as a tool for enhancing the value of a deal,” said Todd R. David, a partner at the Atlanta law firm of Alston & Bird. According to David, some kinds of disputes on representations and warranties may be settled in litigation or arbitration. But because a lot of dealmakers are litigation-adverse, the use of insurance policies can provide a option that can be more appealing. He also said, however, that there are potential drawbacks to using deal insurance, one of which is getting a broker familiar with the policies to issue the insurance. If you don’t have an experienced broker, it can slow down the deal process, he noted. “A lot of times you have two businessmen and their lawyers and they want to sit down and do the deal tonight,” David said. But before issuing a policy, the insurance company’s underwriters have to evaluate the risk in the transaction. Waiting for that analysis can try the patience of executives who are trying to close the pact in a hurry. But where appropriate, deal insurance policies can facilitate smoother transactions. “We see these policies being used as transaction grease,” said Thomas Zacharopoulos, a managing director at Marsh Inc., an Atlanta-based consulting firm. He added that while there are nearly as many variations in policies as there are deals, the basic merger insurance policy provides coverage for buyers. The buyer’s protection guarantees that so-called “operational” reps, such as contracts the seller has, the condition of property being conveyed, and such intangibles as intellectual property, be exactly as described in the seller’s documents. It can also include such potential liabilities as tax concerns, environmental time bombs the target might be aware of, and non-compete stipulations imposed on executives at the selling company. One advantage of using deal insurance policies is that if things start to go sour, the seller need only present its claim to the insurance carrier, which is an easier process than trying to get access to escrow money, which is characteristically held out as a safety value if questions arise about the representations and warranties. A replacement for the escrow fund In fact, one trend among dealmakers in the software industry, according to Zacharopoulos, is to substitute deal insurance policies for the escrow fund. The cost of these policies, in general, is usually between 2.5% and 8% of the amount of coverage purchased. Be-cause many Internet companies have a high percentage of intangible assets, it can be difficult to reach an agreement on what the escrow should be. In these cases, an insurance policy can help the deal go through. Although most deal insurance is issued to protect the buyer, because there are more things that can go wrong in a transaction for the acquirer, it is sometimes used to protect the seller’s interests as well. “The existence of deal insurance for either party can help companies attract buyers,” Zacharopou-los said.