Do private equity firms need to reconsider the use of W&I insurance in Dutch M&A deals during the COVID-19 crisis?
The COVID-19 crisis is forcing private equity firms worldwide to reconsider how to structure, finance and negotiate their M&A transactions. In this post, we discuss the impact of the COVID-19 crisis on the use of W&I insurance in private equity transactions in the Netherlands.
Is W&I insurance still available for M&A deals in the Netherlands?
Over the last five years, buy-side W&I insurance has become increasingly popular with private equity firms as a way of offering sellers in Dutch transactions a clean exit and helping to avoid protracted negotiations about warranties and escrows in competitive auction processes. Due to the large number of insurers and brokers active on the Dutch market, the availability of cover for transactions is not expected to fundamentally change due to the COVID-19 crisis. Transactions in sectors most affected by the crisis, such as the leisure, hospitality, (non-food) retail, travel and energy sectors, could prove more challenging, but there are no signs that insurers are no longer inclined to service the Dutch market.
Are insurers offering coverage for COVID-19-related losses?
As W&I insurance is not intended to cover macroeconomic risks, insurers have been introducing broad policy exclusions for losses related to the COVID-19 crisis. Some insurers are, however, willing to agree to more narrow exclusions tied to specific issues resulting from the crisis, such as factory closures, supply chain disruptions, decreased revenue from material customers or production delays related to labor shortages. While the market is still evolving, it is clear that private equity firms seeking to mitigate COVID-19-related risks will need to rely on traditional contractual risk allocation mechanisms, such as closing conditions, indemnities, purchase price reductions and earn-outs, rather than W&I insurance.
Are insurers reconsidering the type of warranties they are willing to cover?
Insurers are not fundamentally reconsidering the scope of the W&I packages they are willing to cover, but certain customary warranties have come under increased scrutiny. Warranties related to no adverse changes since the accounts date, compliance with health and safety regulations, insurance, customer and supplier relationships and employment are being reviewed in more detail. Where W&I insurance does not offer adequate protection, buyers may need to negotiate additional warranties with the sellers directly, which could be more feasible than before in view of the expected shift from a seller’s market to a more buyer-friendly one.
How is the COVID-19 crisis affecting the underwriting process?
During the underwriting process, W&I insurers will assess whether the buyer has investigated the impact of COVID-19 on the target's business. Insurers are likely to focus on the exposure of the business to certain sectors, such as leisure, travel, hospitality, (non-food) retail and energy, and geographic locations more heavily affected by the crisis. Insurers will also want to review supply chain risks and disputes relating to material contracts. Employment issues such as sick leave coverage will also come under scrutiny. With proper scoping and planning of due diligence, however, the underwriting process need not take longer than usual.
Do insurers have the right to terminate a policy due to the COVID-19 crisis?
In principle, an insurer can only terminate an insurance policy prior to the end of its term if the policy includes a termination right. W&I insurance policies usually do not provide for termination rights on the part of the insurer for force majeure or a material adverse effect. Even if the parties have agreed on such a right, under Dutch insurance law, the insurer can only rely on it if it cannot reasonably be expected to continue the policy. This is not often case. In practice, we do not expect insurers to try to terminate W&I policies. As the warranties insured in M&A transactions generally relate to historic matters not yet impacted by the crisis, COVID-19 should not result in a direct breach of warranties. This conclusion could be different, however, where signing of the transaction occurred before the outbreak but closing takes place afterwards and the warranties are repeated at closing. In this case, the insurer may request a blanket disclosure for any COVID-19 impacts, which as disclosed items will all be excluded from coverage. To protect the value of the policy, buyers will need to resist such requests and limit disclosure to specific events resulting from the COVID-19 crisis.
The COVID-19 crisis presents private equity firms relying on W&I insurance in Dutch transactions with a number of new challenges. However, provided they carefully consider the impact of the crisis on their due diligence, W&I policies and transaction documentation, private equity firms should still be able to effectively use W&I insurance when structuring and negotiating transactions in the Netherlands during the COVID-19 crisis.
Further guidance on developments relevant to private equity and venture capital will be provided in up-coming posts.