For executives who have just completed a merger or acquisition, commencing or continuing an arbitration or court case may be the last thing they want to tackle.
Presumably, the company recently expended a significant amount of money to close the deal, and it’s more likely than not that additional funds were earmarked for the pending integration of two companies following the merger or acquisition. The aversion to pursuing claims—even those worth tens of millions of dollars—may grow, especially if it means taking on both a seller and an insurer at the same time.
Yet an increasing number of companies are facing just such a dilemma. After a purchase, a buyer may discover the seller breached the reps and warranties negotiated as part of the transaction. While those reps and warranties may be covered by an insurance policy, the insurer may decide to deny the buyer’s claims. And in the wake of a large deal, the company may lack the time, energy, and resources to pursue its claims, or it may dispose of the case by settling for pennies on the dollar.
Litigation finance can assist companies facing this scenario. Working with a funder can allow a company to pursue its claims without putting its resources at risk. Funders like Omni Bridgeway (fka Bentham IMF) specialize in providing non-recourse financing for large, highly meritorious claims. The non-recourse arrangement means the funder receives a return on its investment only in the event of a successful settlement or judgment.
With financing from a commercial funder, a company can hire the best possible counsel and maximize its potential recovery. And unlike a bank loan, funding is flexible, and can be used to fund litigation and in some circumstances, may be used for any other purpose the company sees fit—including operational expenses associated with a merger.
An Increase in Claims
The use of reps and warranties (R&W) insurance in transactions has grown during the last several years. Typically, reps and warranties are heavily negotiated aspects of a transaction, with the seller agreeing, within certain limits, to indemnify the buyer in the event of a breach.
Traditionally, roughly 10–15 percent of the proceeds from a sale were held in escrow for one to two years to cover breaches of reps and warranties in a purchase agreement. However, insurance has now taken the place of escrow accounts in most deals. Among other benefits, an insurance policy allows both sides of a transaction to make a clean exit from an investment without the hassle of holding money in escrow.
Perhaps unsurprisingly, the number and size of claims has grown in tandem to the increased popularity of R&W insurance, coupled with the hot deal market of recent years. AIG, one of the largest R&W insurers, reported in 2019 that the proportion of $10 million-plus material claims had nearly doubled during the course of a year. And the frequency of claims rose sharply for M&A deals between $500 million and $1 billion. Overall, AIG said that one in five deals it insures resulted in claims notification.
Taxes, the accuracy and completeness of financial statements, disclosure of material contracts and compliance issues have been the most common types of R&W claims. Tax breaches of various varieties (corporate, employment, and sales) have been a particularly fast-growing source of claims, AIG said.
A Developing Area of Law
According to a recent Forbes article, insurers deny claims for one of the following alleged reasons: (a) an insured’s coverage application was false or incomplete, thus disqualifying the claim as a covered loss; (b) the problem was known by the insured before it signed an M&A deal; the claim involves a covenant from the buyer rather than a rep or warranty; (c) the claimed damages do not exceed the deductible; (d) the language of a particular rep or warranty has not been breached, in the insurer’s view; or (e) the insurance policy carves out the specific claim.
As the article notes, many R&W policies have been subject to mandatory arbitration, and the jurisprudence providing guidance for these claims is limited. “Accordingly,” the authors wrote, “we may not see much development in the law with respect to this type of insurance, as opposed to other areas of insurance law where there has been extensive public litigation and numerous published appellate decisions.”
Yet companies and counsel who seek funding may have an advantage in determining if their claims are likely to produce a strong recovery. In advance of their investments, highly reputable funders conduct extensive due diligence into potential claims. Omni Bridgeway’s litigation finance team is staffed with a group of experienced litigators who are experts in assessing the value of claims and their likelihood for success.
An Even Larger Battle
Because the insurance claims stem from reps and warranties, litigation may not only target the insurer for denying claims, but it may include fraud claims leveled against the seller (inasmuch as claims for fraud typically are specifically carved out in the M&A agreement as well as in the R&W policy). Adding fraud claims expands the size of the litigation—and its expense.
Working with a funder, the insured party can assert its rights, mitigate risk, and reduce out-of-pocket legal costs—without walking away from its claims. Funding can be utilized both in litigation and in domestic and international arbitrations, giving insureds with mandatory arbitration provisions in their policies the potential to qualify for financing.
To learn more about how funding may help your company pursue your meritorious claims, visit our Litigation Finance Education Center, which offers CLE seminars to companies interested in working with funders and our recent client podcasts, blog posts and videos. Or contact us for a consultation for more about the ways we can help.