There is no question the global pandemic is disrupting the M&A landscape, injecting significant uncertainty into the deal-making market. In addition to delaying or derailing potential transactions, Covid-19 is forcing M&A practitioners to assess appropriate risk allocation mechanisms to address the impact of the virus on global business operations, including Representations and Warranties Insurance (RWI).
Buying opportunities still exist, but a higher risk tolerance will be needed as buyers become less certain. Ultimately, it could become extremely difficult, if not impossible, to value a company for some time in the future.
Aon’s Transaction Solutions team has been monitoring and working to understand how Covid-19 is affecting RWI policies. The full impact of Covid-19 on underwriting and scope of coverage is still developing in real time. But until we can understand the scope and fallout of the pandemic more clearly, we can offer three insights we believe dealmakers should consider now when using RWI as an effective risk allocation tool:
Watch for overly broad exclusions
R&W insurers are paying close attention to the current and potential effects of Covid-19 on the operations of the target and how those risks may radiate through the R&W in the Transaction Agreement, with some insurers proposing exclusions related to Covid-19 that can vary in scope. Aon is working closely with clients to avoid any overly broad exclusions and, where unavoidable, to tailor the language of an any proposed exclusion as narrowly as possible.
Expect heightened diligence around virus impact
Covid-19 will likely impact long-settled M&A clauses, from the determination of “Material Adverse Effect” prior to closing, to interim period operating covenants, to satisfaction of closing conditions. As part of the RWI underwriting process, clients should expect increased diligence around virus impact, particularly with respect to workforce and supply chain disruption.
Longer interim periods could mean greater scrutiny
Deals with longer interim periods and more potential for deterioration of the target’s business between signing and closing will endure greater underwriting scrutiny around operations and expected performance prior to closing, as well as heightened focus on the buyer’s ability to monitor any adverse developments.
From a claims perspective, RWI policies cover unknown, historical, disclosure-related issues that result in losses to the policyholder. For example, if a seller does not disclose a target company’s default under a contract with a material supplier, that failure likely constitutes a breach, and the loss resulting from such breach should be covered. The breach could impact the target’s supply chain and lead to a severe devaluation of the entire enterprise. However, if the same contract simply doesn’t perform post-closing due to a change in the economic environment, that is a business risk that typically would not be covered.
The current risks posed by Covid-19 seem to operate at the intersection of these two frameworks. Nevertheless, policyholders must be able to rely on RWI policies to provide coverage for claims that arise from a breach of a representation and to reimburse for losses that are causally connected to that breach and are not simply the result of deterioration of revenue/production post-closing due to Covid-19 impact. Policyholders should also look to policies such as business interruption and related lines of insurance when assessing their available insurance coverages.
The M&A insurance market has adapted to new and unexpected risks in the past and evolved to address those risks effectively. Aon’s Transaction Solutions team is available to discuss any issues related to Covid, and we continue to work with our clients, their advisors and insurance carriers to ensure that RWI continues to respond to our rapidly changing landscape in these tumultuous times.