Shift the Paradigm and Mitigate a Buyer’s Risk in Take Privates and Public M&A

Buyers of public companies in take-private and public-to-public transactions have historically accepted that they will have little or no recourse for a breach of the representations and warranties (R&W) contained in the transaction agreement. With a broad public shareholder base, it would be infeasible to ask shareholders to stand behind an indemnity or bring a claim against them. As such, the expectation in public M&A transactions from the buyer, the target board and management and the advisors involved is often that there will be no post-closing indemnity and a limited set of R&W will be given. The lack of a post-closing indemnity and minimal recourse has been accepted by some buyers as a risk of doing public M&A transactions and, correct or not, many have rationalized it through the collective belief that as the target is subject to a public company audit and reporting requirements the transaction is inherently less risky.

While some buyers have resigned themselves to the status quo that public M&A transactions will mean limited recourse and increased exposure in the event of a R&W breach, others are shifting their focus to a staple of private M&A: R&W insurance (RWI). The use of RWI on public M&A transactions has understandably lagged behind its adoption on private M&A transactions, as there was generally no indemnity to replace. However, as buyers, have had renewed interest in public M&A transactions in recent years, some are looking for ways to get meaningful private M&A style protections on public M&A transactions. This is not dissimilar to other transaction structures such as secondary transactions, minority transactions and de-SPAC transactions, where buyers have increasingly used RWI to help mitigate risk.

2021 was a record year in North American and Global M&A, but 2022 has seen a slow-down from that record year in both M&A volume and value as economic and geopolitical headwinds have slowed deal-making. However, public M&A transactions have continued to increase in popularity despite the slow-down. In 2021 there were 47 announced take-private transactions of U.S. listed companies, up from 33 in 2020 and the most since 2010. Through the first week of June 2022, 32 take-privates have been announced, compared with 20 such deals by the same time last year,¹ and observers expect this trend to continue with a wave of take privates for technology issuers that have seen their share prices crash.

For buyers seeking to subvert the status quo and get private M&A style protection on public M&A transactions, placing an RWI policy can provide the buyer with recourse against an insurer for a breach of the R&W, rather than the shareholders of the public company, or the public company itself, solving one of the structural challenges. However, other key challenges to consider include timing and diligence, and the R&W package being given a greater level of disclosure.

Buy-side RWI coverage in any context has always been dependent on a buyer’s ability to perform thorough diligence, which is then shared with R&W insurer(s) to help them gain comfort on the scope of the diligence and that there are no unknown or unscheduled breaches of the R&W. On a public M&A transaction, the buyer is still expected to receive full access and to perform meaningful diligence, as would be required in the private M&A context. Practically, this means that it will need to be a friendly (non-hostile) deal so that the buyer has the necessary access, and the buyer will need the appropriate time to complete their diligence and get through RWI underwriting on a traditional, expedited timeline. Alternatively, coverage can be bound in the interim period between signing and closing if the need to sign and announce the deal outpaces the completion of RWI underwriting.

One of the key benefits of RWI in North America has traditionally been the application of a “double materiality scrape” both for determining the existence of breaches and for calculating loss arising from a breach. R&W insurers have been willing to offer this in the private M&A context on the assumption that the disclosure schedules are being populated without respect to materiality, but on a public M&A transaction the disclosure schedules will often be qualified with reference to what has been publicly disclosed. If a buyer is unable to have a seller create and populate more thorough disclosure schedules to facilitate more meaningful RWI coverage, one solution is to have a de minimis claim threshold applied so that coverage is consistent with the level of the disclosure.

Furthermore, in a public M&A transaction, many of the R&W being given may be qualified by a material adverse effect (MAE) standard. This can limit the perceived utility of an RWI policy as the R&W being covered are not as extensive as what a buyer would receive in a private M&A transaction. This can be mitigated by approaching the seller early in the process and having them provide a less qualified set of representations to facilitate a buyer’s RWI coverage. Alternatively, if the sellers are demanding a more traditional set of public R&W, insurers should have increased appetite to cover them at a reduced price given the lesser scope of coverage.

With an increasing number of public M&A transactions and an increased appetite from R&W insurers to cover these types of transaction, Aon is well positioned to work with buyers to help them move away from the traditional limited recourse structure by placing an RWI policy and preserving the right to make a meaningful recovery.

If you have questions about your coverage or you are interested in obtaining coverage, please contact your Aon broker.

All descriptions, summaries or highlights of coverage are for general informational purposes only and do not amend, alter or modify the actual terms or conditions of any insurance policy. Coverage is governed only by the terms and conditions of the relevant policy.

¹ Source: Dealogic. Numbers also cited in WSJ article (https://www.wsj.com/articles/taking-a-company-private-brings-new-risks-responsibilities-for-directors-11654767001)