UK: Private Equity Sound Bite - September 2012

Last Updated: 18 October 2012

Article by Perry Yam, Mark Pedretti, Philip Taylor, Dr. Justus Binder, Marc Fredj, Lucas d'Orgeval and Emmanuel Vergnaud

Warranty & Indemnity Insurance

In a market where deal execution is proving challenging, one of the ways of addressing risk and closing the divide between buyers and sellers is insurance.

Warranty and indemnity insurance is available in private equity and M&A transactions to cover either the buyer or seller for losses resulting from breaches of the seller's warranties or indemnities. This coverage can serve as a complete substitute for or partial supplement to, other forms of financial guarantees for the seller's warranty and indemnity obligations.

A seller policy will typically pay out the indemnity owed as a result of a breached representation or warranty to the buyer. Coverage purchased by the buyer can provide the same protection, but the insurer will have a subrogation claim against the seller for any breach. An insurer can be asked to waive or limit its subrogation rights, enabling the deal to be structured so that the buyer's sole recourse in the event of a breach is the policy, absent fraud. Although policies differ in their wording, they generally provide coverage for defined risks from one specific warranty/indemnity or a whole list of representations and warranties.

Insurers may dispute whether a particular representation or warranty was fraudulent, known to be false, or should have been known to be false before the deal and the insurance purchase. Negotiations can specify that "actual" knowledge of fraud is required to exclude a loss, and the group of individuals at the seller whose knowledge "counts" can be narrowed. If the goal is to set a price for a known risk that has not yet occurred or been quantified, the policy should be written to reflect that.

These policies usually only cover existing or past conditions and do not cover covenants about future conduct or contingencies yet to occur. If there is a concern about ongoing or future risks inherent in an M&A transaction, other insurance policy forms may be necessary, such as coverage for ongoing litigation, an aborted bid, future pollution liabilities, projected profitability or income streams, future tax treatment, and liabilities of officers and directors.

The cost of a policy will vary depending on the nature of the risk covered. Premiums of 1–2% in the UK (and 3–10% in the US) are typical. If one party to an M&A transaction uses this type of coverage without the knowledge of the other party, dramatic savings may be realised. For example, if both buyer and seller are aware of a risk, but dispute its value and who should bear it, one party might negotiate a change to the deal price for accepting the risk that is far greater than the insurance premium. In such instances, the insurance company may seek a greater premium to "share" in the value added to the deal by the insurance policy.

Management Equity Participation

Reed Smith has extensive experience in advising management teams and companies on equity and other incentive plans in the UK and overseas. Our team acts for private equity funds tailoring incentive schemes for their portfolio companies. The delivery of tax-efficient and commercial employee incentives is an important ingredient to the future success of a company. Our group is a leader in the design of bespoke and tax-effective incentives, as well as more standard approved and unapproved plans. We advise on related company law, employment law, regulatory, corporate governance and trust law issues. Jeremy Glover leads the UK Employee Incentives Group which specialises in advising clients on the design, implementation and operation of all incentive arrangements.

Transaction Highlights

Deals Across the Team

Advised Indigo Capital LLP, the long-established investment management firm specialising in the provision of mezzanine and junior capital to privately owned European businesses, on its investment in AVM Limited which provides design, installation and support for integrated audio visual communications systems. This investment was provided alongside Alcuin Private Equity, with Indigo providing senior term debt as well as investing equity into the business. Perry Yam and Lucy Newcomb advised on the deal.

Advised Oakfield Capital Partners LLP, a private equity company focused on special situations in the UK, on a round of fundraising for portfolio company Ingresso Group Limited. Ingresso provides ticketing technology that benefits the suppliers and distributors of tickets, such as venue and event box offices, theme parks and attractions, ticket agents, tour operators, and event producers/promoters. Perry Yam and James Cross worked on the transaction.

Instructed by Hermes GPE in the capacity as manager of the BT Pension Scheme in the acquisition of a 13% interest in Thames Water from Macquarie. This is the first transaction that the new Private Equity Team at Reed Smith has worked on with Hermes GPE. Perry Yam and Joanna Hamilton advised Hermes.

Advised Cosfibel, international supplier of packaging and merchandising solutions for the cosmetics, gourmet foods and luxury industries, on its acquisition of Solvpack. Solvpack is a €10 million turnover (2011) group specialising in packaging for champagne bottles, with a head office in France and a subsidiary in Hong Kong. This transaction is part of Cosfibel's rapid development strategy in which Reed Smith plays a recurring role. Paris Corporate partner Emmanuel Vergnaud and Tax associate Stéphane Letranchant advised on this transaction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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