SINGAPORE (June 19): As the Covid-19 pandemic evolves there is a heightened push to renegotiate deal terms. 

Several deals have been stalled or cancelled, specifically in healthcare and aged care; tourism, F&B and hospitality; logistics and supply chain; and oil and gas sectors. This is primarily due to border closures and business interruptions, resulting in the re-evaluations of target companies’ existing business models and financial forecasts.

Furthermore, the increasing trend of companies seeking capital to improve liquidity will inevitably bring to the table private equity (PE) funds and other investors specialising in the turnaround space. Given the stock market volatility, PE funds will also be seeking value in “take-private” transactions. Under these circumstances, insuring M&A transactions would be quite challenging for companies.

Covid-19 coverage concerns
While insurers are not flagging a significant change in their appetite for insuring M&A transactions until the picture becomes clearer, they are inclined to take a more cautious approach to the jurisdictions and target sectors currently most affected by Covid-19. Nevertheless, an upward trend of premiums is unlikely, as competition between insurers will intensify amid lower deal flow.

Insurers are reacting to the risks presented by Covid-19 through enhanced underwriting and/or additional potential exclusions from coverage from the outset. In the first instance, certain insurers have now flagged the potential need for exclusions from cover in the event they are unable to gain comfort on the impact of the pandemic on the warranties, particularly in relation to warranties to be given at completion. Insurers are usually more concerned over businesses where supply chain and cash flows may be impacted, or where there may be a threat of closure of business. If companies demonstrate that the target business is not significantly exposed to such threats, they maybe able to justify removal of such exclusions.

In addition, insurers who now have the time and opportunity to analyse the impact of the pandemic have started to take a more commercial approach with respect to a mandatory Covid-19 exclusion. Such blanket exclusion may not be required where an insurer can tailor specific warranties to be amended to address their concerns.

Ultimately, if a Covid-19 exclusion is insisted upon by insurers, they will need to ensure that it is drafted as narrowly as possible to ad-
dress the underwriters’ specific concerns, and avoid it applying too broadly across the entire suite of warranties.

Areas of increased underwriting focus

Since the progression of the pandemic, insurers have increased their underwriting focus in areas such as general supply chain risks, financial stability, business continuity and disaster recovery plans. The heightened focus, in these sectors, stems from a health and safety concern, as well as the potential of defaults in these businesses, as more countries move from containment policies to delay-based strategies.

Employment issues, such as coverage for unpaid wages, sick leave and data protection related to employees and health, will also become a key area of focus. For transactions structured with a split signing and completion in particular, insurers will consider the target company’s material contracts, with a focus on the ability of performance, together with the consequences of non-performance.

As such, companies must ensure they update their diligence exercises accordingly, including taking into account a detailed analysis of the target company’s insurance programme, and confirmation that business interruption cover in policies do not contain epidemic/pandemic exclusions; and whether any coronavirus-related claims will be covered by the key health-related insurances.

Scrutiny on target valuation
Insurers are also likely to look closely at the valuation of the sector in which the target company operates to ensure that the pricing multiple makes sense, considering the current economic environment.

As losses are calculated based on the difference between the buyer’s purchase price and the actual price of the shares post-discov-
ery of breaches, insurers will need to know if the buyer is overpaying for the target (based on objective metrics). The underwriters will focus on the extent to which Covid-19’s future impact has been factored into the target’s valuation (particularly where the valuation methodology is based on discounted cash flow).

In this case, it will be important for buyers to demonstrate that they avail themselves of up-to-date management accounts and other information, and have a clear understanding of the impact on the target’s business.

Gap between signing and completion
Given the uncertainty in the market and how quickly the pandemic is evolving, we anticipate that buyers will look for enhanced termination rights via material adverse effect (MAE) clauses in between signing and closing.

Warranties and indemnities (W&I) insurance policies will generally follow the terms of MAE clauses and fall away if such a clause is triggered; hence, buyers will need to think carefully about the breadth of language drafted. It is important to ensure that policies remain in force even if parties agree to close following a MAE event (although any loss flowing from the matter which gave rise to the MAE event will not be covered under the W&I policies).

Furthermore, while insurers now perceive a heightened material risk between signing and completion, they will continue coverage of new known breaches, provided that they have sufficient protection within the policy regarding Covid-19 and the MAE clauses.

Sandra Lee and Aris Wong are Head and Director, respectively, of Transaction Liability Insurance, Asia, at Aon