A portion of this article was published in ABA’s Business Law Today Month-in-Brief
As many of the participants in the private M&A market know, a representations and warranties insurance policy (or RWI) is a bespoke policy that can be folded into an M&A deal to transfer some of the risk from the deal parties to the insurer. This type of policy protects the insured (typically the buyer) from the seller’s breach of its representations and warranties in the purchase or merger agreement. A typical RWI policy contains several standard exclusions for things like known issues, covenants, and liability arising from pension underfunding and asbestos. However, when COVID-19 arrived, insurance underwriters introduced a new COVID-19-related exclusion.
COVID-19 RWI Exclusions
This kind of an exclusion began to appear in RWI policies in early March of 2020. Initially, it took the form of a blanket exclusion from coverage for any claims or issues that related in any conceivable way to COVID-19. Examples of blanket exclusionary language included statements like “the policy will exclude losses that are attributable to negative effects of COVID-19 and related viruses” and “the policy will exclude losses for, arising from or based upon coronavirus (including any resulting COVID-19 sickness, SARS-CoV-2, or any mutation or variation thereof) or any voluntary, government or other regulatory sanctioned or recommended response thereto.”
Not surprisingly, insurers received a lot of push back from the market in response to this type of blanket exclusionary language. The insureds and the insurance brokers argued that such broad language could be interpreted to exclude almost all claims because all business and other activities of the target companies were bound, at least in the immediate future, to somehow relate to COVID-19. To find a palatable middle-ground, over the next few months the insurers began introducing exclusion modifications until AIG ultimately led with the following language, which, at the moment, remains the narrowest in the market: “policy would exclude any losses arising out of, resulting from or to the extent increased by the failure to protect any employee, contractor, officer, director, manager, agent, customer, client, supplier, distributor or any other person from the transmission of a novel coronavirus, including the coronavirus disease (COVID-19) or any evolution thereof.” With this narrow language, however, AIG also took the opportunity to introduce a premium pricing increase. A few insurers followed with similar exclusionary language almost immediately after and some also introduced pricing increases. Others are likely to do both as well in the coming months.
Interim COVID-19 Exclusions
Another interesting development occurred in the form of an “interim” COVID-19 exclusion—one that would stay in the policy at the time of singing of the purchase agreement, but that could be removed at closing. An example of this interim exclusion looks like this: “policy would also exclude any losses arising out of, resulting from or to the extent increased by a Breach that first occurred during the Interim Period or at the Closing arising out of, resulting from or to the extent increased by (a) the presence, transmission, or threat of a novel coronavirus, including the coronavirus disease (COVID-19) or any evolution thereof, and/or (b) any mandatory or advisory restriction issued, or action ordered or threatened, by any public authority, regulatory body or government in connection therewith including any federal, state, local or foreign regulation, rule, statute or law.” An insurer is typically open to modifying or removing this interim exclusion at closing as long as the insurer is satisfied with the due diligence provided immediately prior to closing.
Questions About COVID-19 from M&A Insurers
Insurers are likely to ask questions relating to the following topics to help them get to a satisfactory position on COVID-19 and allow them to remove the interim COVID-19 exclusion: (1) the extent of the continued impact of COVID-19 on the company; (2) the nature of the discussions between buyer and seller relating to the impact of COVID-19 on the target’s business in the interim period; (3) a list of instances of COVID-19 cases or illnesses at the target; and (4) the nature of any concerns expressed by the target’s customers or suppliers about meeting targets or maintaining expected levels of activity.
The exact evolution of the COVID-19 exclusions in representations and warranties policies is difficult to predict, but they are likely to become less stringent and more focused on the target’s business and the particular conditions of the target as well as the due diligence conducted by the buyer’s team and outside third-party advisors. A recent 2020 Claims Study published by Liberty Global Transaction Solutions is anticipating new COVID-19-related trends to emerge in the next 12 months. The study is predicting that insurance underwriters will more closely focus on areas of exposure relating to: (1) “third-party claims, including in connection with labor-related issues and material contracts that have been terminated on the basis of an apparent force majeure;” (2) “claims relating to key customer insolvency where, pre-signing, there were circumstances that were known to the warrantors that indicated that the relevant customer was in financial difficulty;” and (3) “claims relating to the incorrect use of the various job retention schemes that were implemented by national governments in the wake of COVID-19.”
A Strong Year for M&A, Continued Adoption of RWI
It is also not too long of a stretch to predict that going into 2021, which by all accounts is going to be a strong year for M&A, insurers will be pushing a gradual increase in premium pricing for RWI policies. The RWI market is continuing to experience an uptick in volume which began at the end of the summer. One of the insurance markets, Euclid Transactional, has been posting the numbers of submissions it has received and policies it had bound in the last few months. They are seeing a continual increase in the volume of activity. As a result, the cost of their US primary policies rose by over 25% compared to October 2019.
Other market participants, including attorneys, brokers and others, are also seeing a significant increase in the overall M&A market activity over the last three to four months. While we have definitely been a witness to the heated M&A market, we have not seen such significant price increases across the market spectrum.
Generally, however, the continued increased market activity, strong M&A market outlook going into 2021, continued adoption of the RWI as a product across the private M&A arena, the recent history of large claim payments from a number of insurers, better understanding by insurers of claim risk, and the additional risks brought on by COVID-19, will all contribute to a gradual increase in RWI policy pricing in the next few months.
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