A ‘standard’ approach does not work every time
Imagine you’re the CFO of a PE-backed portfolio company buying a business from a FTSE100 listed company. Engagement with the target management has been good – they are in the same sector as you – and disclosure appears to be thorough. With the help of your lawyers, you’ve negotiated a solid SPA, including a good set of warranties. But these warranties are only given at signing, not repeated at closing, and despite your best efforts the seller is not prepared to provide a MAC clause. You like the deal, but you need some protection in case an issue arises between signing and closing – because as it stands, if an issue arises that is not a breach of a signing warranty, you will still have to complete and pay the agreed purchase price but will have no right of set-off or recovery against the seller. Worst-case scenario? …this means having to go ahead and buy a business with a known problem. Not only does that not make economic sense, but it will also make for an uncomfortable conversation with your shareholder.
The case for a fresh perspective
The scenario above presented itself to RCA earlier in the year, and we helped our client to overcome the barrier on their deal, by taking a fresh perspective on W&I. Running contrary to the usual way of thinking about W&I, where ‘new breaches’ which occur and are discovered between signing and closing are excluded, RCA set out to obtain a policy to cover exactly that risk. Our perspective was clear – with the right combination of business type, retention level, wording and policy duration, an insurer might have the appetite for the risk.
We discussed the risk with select insurers, explaining that the business operated in one country, with mainly long-term stable contracts, and with no history of claims. We then proposed a higher retention, as the buyer was really only concerned about significant events, so rather than a retention of 0.5% of enterprise value that would be typical on a W&I policy, we suggested a 10% retention. The policy period was only for sixty days, with some premium repaid if the deal completed earlier.
The use of synthetic completion warranties
The outcome was a policy which synthetically repeated the signing warranties as closing warranties and covered a breach of those synthetic closing warranties. Any issue which could be a claim under the signing warranties was excluded, along with breaches of various deal specific covenants and conditions related to the period between signing and closing. The buyer had the comfort that even if a significant issue was identified between signing and closing which negatively impacted the value of the company, they could still complete the deal and obtain recourse under a policy.
Contact the RCA team if you would like any more information on the innovative use of W&I.