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Safeguarding Against Identified Legal Risks With Contingent Risk Insurance
Navigating new forms of volatility
In today’s fast-paced commercial environment, companies grapple with a myriad of identifiable risks that can potentially disrupt their operations, cause financial instability and lead to a loss of investor confidence. Identified known risks may arise as a red flag in the due diligence process and consequently block a mergers and acquisition (M&A) transaction from proceeding if neither party to the transaction is willing to bear the risks.
While conventional insurance policies guard against common perils in a business-as-usual context, there is a need for a more targeted and tailored approach when it comes to identified legal risks. This is where contingent risk insurance steps in as a potential game-changer, providing coverage for known uncertainties and transferring these risks to the insurance markets. Contingent risks coverage is wide ranging and includes legal risks such as those arising from litigation, tax liability and regulatory issues.
Using litigation risk insurance, disputing parties may be able to mitigate against material financial risks arising from an adverse judgment and/or related cost orders against them. Parties with a favourable judgment at the lower courts could also consider judgment preservation insurance which preserves the judgment sum on a favourable lower court decision.
Contingent Risks Beyond Litigation
Outside of litigation, contingent risks come in broad and diverse forms, but they share the common features of risks that are capable of legal analysis and evaluation. Such risks are typically low in probability but high in severity. Examples of potentially insurable risks include:
- Risk of a regulatory body determining that a business has been operating without the necessary permits or licenses or that it has been operating in breach of their terms.
- Risk and uncertainty flowing from counterparties’ differing interpretations of contract terms.
- Risk of defective goods and clean title to shares due to past irregularities.
- Risk of an adverse interpretation of a law or regulation, which can impact the contractual entitlement to payment.
Case Study: Contingent Risks in a Distressed Context
Contingent risk insurance can also apply in a distressed situation. In this example, a client was acquiring companies from a group that were facing financial difficulties. As part of the sell-side reorganisation, certain assets were being transferred into and out of the entities. There were concerns around the application of the law on “transaction at an undervalue” on the transfer of these assets. The buyer of the companies was concerned that, in the event of a post-sale insolvency of the selling group, creditors might persuade a liquidator/administrator to challenge these transfers, leaving the buyer with an unsecured claim against an insolvent entity.
In this case, Aon was able to arrange for a policy covering the risk if the transactions undertaken by the target companies prior to the sale were considered “transactions at an undervalue” and set aside as being void. This meant that the insurance allowed the buyer to recover the value of the “clawed back” assets including any associated costs.
To obtain a contingent risk insurance policy, organisations are required to obtain a legal opinion setting out:
- The factual background and circumstances which led to the legal issue
- An analysis of the applicable law and/or regulation
- A clear and quantified conclusion as to the likelihood of the risk materialising
- Details of the loss that may be suffered.
Contingent risk insurance is a useful tool for strategic business decision-making and may help to break an impasse in deal negotiations. By providing financial protection against these specific defined risks, it helps to facilitate compromise while pushing the deal forward. Beyond the confines of M&A, it is an effective and versatile risk management tool that can be used by businesses as a safety net for distinct risks which allows the commercial team to focus on value creation.
For more information on contingent risk insurance, talk to our specialists:
Cathryn Neo
Associate Director, Litigation and Contingent Risks, Singapore
+65 8129 3425
[email protected]
Associate Director, Litigation and Contingent Risks, Singapore
+65 8129 3425
[email protected]