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Reps and Warranties Insurance in M&A:

Critical Tool to Mitigate Risk and Close Deals Evaluating When Insurance is Appropriate, Negotiating Coverage and Exclusions

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

THURSDAY, JANUARY 21, 2016

Presenting a live 90-minute webinar with interactive Q&A

Jonathan Gilbert, Senior Managing Director, Crystal & Company, New York

Jonathan Kim, Partner, Dechert, New York

Mark E. Thierfelder, Chair, Corporate and Securities Practice, Dechert, New York

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PRESENTED BY pg .

REPRESENTATIONS & WARRANTIES

INSURANCE

Jonathan Gilbert Senior Managing Director Crystal & Company

5

1 /21 /2016

Mark Thierfelder Partner Dechert LLP

Jonathan Kim Partner Dechert LLP

pg.

Protects against unanticipated seller’s breaches of representations and warranties and losses that may arise post-close.

Cover provided for all fundamental and non-fundamental representations and warranties.

RWI used to reduce or eliminate seller indemnity or escrow.

Policy can be secured by a buyer or seller (“Buy Side” vs. “Sell Side”)- 90%+ of RWI policies are “Buy Side” policies.

Can potentially provide additional protection over specified indemnities.

RWI is NOT intended to provide protection:

– Actual Knowledge of a breach – Forward Looking Statements – Specific reserves on a balance sheet – Fraud – Underfunded Pension obligations – Absence of “standard due diligence” – Working Capital Adjustments – Intentional Acts

6

Overview of Representations and Warranty

Insurance (RWI)

pg.

Uses of Reps and Warranties Insurance

Buyers

Risk Management Uses:

Increase maximum indemnity / extend survival period for breaches of reps & warranties

Ease collection concerns

Provide recourse when no seller indemnity possible (public company sales, bankruptcy)

Strategic Uses:

Distinguish bid in auction

Protect key relationships

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Sellers

Risk Management Uses:

Reduce contingent liabilities

Distribute sale proceeds

Protect passive sellers

Strategic Uses:

Attract best offers by maximizing indemnification

Include R&W Insurance as the sole remedy in draft agreements in auctions

pg.

Representations and Warranty Insurance

Common Policy Structure

Policy Term:

– 3-6 Year Term For Non Fundamental

Representations

– 6 Year Term for Fundamental

Representations/Tax

Retention/Deductible:

– 1-2% of Purchase Price

– Escrow/Indemnity can serve as funding

of retention/deductible

Current Market Cost:

– Premium: 2-4% of limits purchased (3-

4% more common)

– State Taxes: (2-4% of premium)

– Underwriting Fee: $15,000 - $50,000

8

pg.

Representations and Warranty Insurance Benefits to Buyer:

RWI up to 6 Year Policy Term vs. 12-24 month survival period.

RWI Policy Limit 100%+ of Purchase Price vs. 5-10% indemnity cap.

Triple AAA rated asset backstopping indemnity vs. seller.

Seller/post-close management focused on growing business (don’t sue Newco CEO).

Ease Negotiation of Transactional Terms: – Seller more amenable to longer survival

periods, broader reps, etc. if RWI is being contemplated.

Stay competitive in bid process.

Greater protection for LPs.

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Benefits to Seller:

Accelerated deal proceeds.

Greater certainty of deal proceeds.

Cleaner “exit” when multiple seller’s involved.

No need for all sellers to secure protection.

Financial Sponsors, shorter timeframe to close out funds (Quarterly reports, filings, etc.).

Partially Pre-negotiated policies can be offered during bid process.

The contemplation of RWI can create a “moral” hazard risk by insurance carriers and strength of representations/standard of care related to due diligence are carefully reviewed throughout underwriting.

pg.

Representations and Warranty Insurance Considerations:

Cost Impact – Who Pays?

Additional negotiation needed around policy language

Who is responsible for losses within deductible / retention?

Deductible/retention of policy may not be reduced by other “specific indemnities”

Additional party involved in resolving indemnification claims

Indemnification for fundamental representations & warranties may be unlimited in deal structure but capped under RWI

Right to Defend

Subrogation

Definition of Loss

Named Insured/Indemnified Parties/Ability to Direct Payment of Proceed- track with “seller’s representative”

Common Exclusions: – Actual knowledge – Fines/penalties (where uninsurable by law) – Environmental (varies by industry/target) – Underfunded Pension liabilities – Asbestos

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pg.

Representations and Warranty Insurance

Market Evolution

11

Market Condition 2007 2015

Pricing 5% - 7% limits Purchased 2% - 4% of Limits Purchased

Retention 2-3% of Purchase Price 1-2% of Purchase Price

Terms Heavy Exclusions Better Mirrors Terms of Agreement

Number of Markets 5 Primary Markets 10+ Primary Markets

Aggregate Capacity – Per Transaction

$200 million $400 million+

Estimated Frequency of Use U.S. – 1% /Europe – <5% U.S. – 6% /Europe – 15%+

Claims Activity Nil Hundreds of Millions Paid by Carriers Globally

Underwriting Process Slow Quickly as a few days

pg.

Representations and Warranty Insurance

Current State of Market:

10+ U.S. insurance markets able to provide primary RWI policies.

Ample insurance capital.

Policy Limits in excess of $400 million.

Minimum coverage levels drastically reduced.

Multiplied Damages/Material Scrape.

Recent Dechert Study: https://www.dechert.com/Representation_and_Warranty_Insurance_No_Longer_Optional_07-09-2015/

Emerging Issues:

– Industry: Financial/Healthcare sector

– International Law/FCPA-Anti Bribery

– Employment Matters

– Medicare/Medicaid exposure

– Equity rollover

12

pg.

Representations and Warranty Insurance

Underwriting Process

Step 1: Non Bindable Indication Letter (NBIL):

– Timing: Typically less than one week to obtain indication – Data Required: Draft transaction agreement, financials, summary of target – NBIL: Premium, Limit, Term, Deductible/Retention, and identified area of concerns – Payment of underwriting fee

Step 2: Underwriting:

– Timing: 1-2 weeks – Underwriting/Audit of Due Diligence:

Documents: Review of buy side due diligence reports, data room, memos All Hands On Call: 2 hour call to review due diligence matters identified and underwriter

questions. Follow Up questions/requests

– Policy Language: Negotiation of policy form to ensure policy mirrors terms of agreement. (attorney specific forms, financial sponsor forms have been developed)

13

pg.

When to Begin Discussion of RWI?

Representations and Warranty Insurance

Buyer:

Auction process.

Contemplate in LOI stage.

At an impasse over indemnity offered (time or dollar amount).

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Seller:

Prior to Market- “Pre-Arranged policy terms”.

During negotiations.

Post sale.

pg.

Representations and Warranty Insurance

Claims Experience (North America)

25% of RWI policies have noticed a “potential claim/breach of representation”.

Carriers have made hundreds of millions of claim payments over past ten years.

Most common types of claims:

– Tax

– Compliance with Law

– Financial Statements (reserves)

– Material Contracts

– Intellectual Property

– Employment Matters

– Customers

15

pg.

Representations and Warranty Insurance

Claims Experience (North America)

16

Claims by Deal Size Timing of Claims

pg.

Claims Example

Representations and Warranty Insurance

• Product Recall

• Financial Statement Reserves

• Inflated Earnings (including allegation of fraud by seller)

• Intellectual Property

• Employment Matters

17

Accounts Receivable:

– Acquisition of a restaurant chain by a strategic purchaser for over $78 million.

– Claim brought by buyer against seller who in turn submitted claim under “sell-side” policy for breach of financial statements/accounts receivable in connection with the target's issuance of over $1 million of gift certificates which had not been recorded in the financial statements.

Claim Resolution:

– The buyer’s auditors presented a report itemizing alleged breaches/damages resulting therefrom. Carrier paid a significant sum in settlement and expenses to resolve the claim.

Active/Resolved Claim Matters

pg.

Jonathan Gilbert is a Senior Managing Director in Crystal & Company’s Commercial Insurance Services unit, specializing in Private Equity. Jon has over 11 years of Mergers & Acquisitions insurance experience and leads Crystal & Company’s Private Equity/Mergers & Acquisition group. In addition to due diligence expertise, Jon has led insurance procurement initiatives for private equity firms nationwide, with a focus on reducing expense and increasing liquidity. Jon has worked with insurance markets to develop one-off risk transfer solutions to solve deal related issues, including insuring against breaches of representations & warranties and other contingent liabilities.

He brings a wealth of expertise regarding risk management issues and its financial impact to buyers including traditional leverage buyouts; public-to-private sales; debt/equity swap; asset sales out of bankruptcy; and corporate divestitures to name a few. In 2014 Jon was named as one of M&A Advisors’ “40 Under 40” award recipients. And in 2015, Jon was named as of Business Insurance’s “40 under 40” award recipients. Jonathan is a frequent speaker on Representations & Warranty Insurance and was recently featured in Buyouts magazine January 11, 2016 article on emerging trends regarding Representations & Warranty Insurance.

Prior to joining Crystal & Company, Jon was a Senior Vice President in Marsh’s Private Equity Mergers & Acquisitions Group. Prior to Marsh, Jon was a senior Project Manager in Lockton’s Mergers & Acquisitions Group. Jon began his career with multiple insurance carriers, last working for a subsidiary of Travelers Insurance Group, focused on drafting and amending Directors & Officers Liability policy documents. Jonathan also worked for Hartford Insurance Group, in the statutory accounting unit.

Jon received his Bachelor of Arts in Communications and Bachelor of Science in Finance and Economics from University of Hartford.

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Jonathan Gilbert, Sr. Managing Director, Crystal & Co. jonathan.gilbert@crystalco.com

pg.

Mark E. Thierfelder is chair of the firm's corporate and securities group and chair of the global private equity practice. He concentrates his practice on private equity transactions and domestic and international mergers and acquisitions throughout the U.S., Europe, and Canada. In particular, Mr. Thierfelder represents leading private equity funds and their portfolio companies in a full range of corporate transactions, including mergers and acquisitions, recapitalizations, leveraged financings, restructurings, and reorganizations. In addition, he negotiates, structures, and executes corporate transactions on behalf of strategic buyers and sellers, and has significant experience representing banks and other institutional lenders in leveraged financings and restructurings. Mr. Thierfelder is consistently recognized as a leading Corporate/M&A lawyer in New York by the legal directory Chambers USA, where he has been described in recent editions as “a businessperson's attorney,” who "has a great sense of deal dynamics and what's really going on" and is “very knowledgeable and understands the nuances involved in everything he handles.” Clients have noted he is “a fantastic leader” and “one of the most sophisticated lawyers” who “possesses a command of the entire deal process, has great commercial awareness and a good temperament for negotiating with the other side.” He has also been listed as a top private equity and mergers and acquisitions lawyer for the past nine years by The Legal 500 (U.S.), which singled him out as an “outstanding business lawyer,” and a "recognized expert in private equity transactions." The Legal 500 (U.S.) has also stated that he does a “stellar job” with “very good commercial sense” and that clients “value his advice and his commitment greatly.” In addition, Mr. Thierfelder has been selected as a leading lawyer for both M&A and private equity in the IFLR 1000. He is also a frequent speaker on mergers and acquisitions and other corporate and securities topics, and has been featured on CNBC as well as in The Deal Pipeline, Mergers & Acquisitions magazine, Investment Dealers’ Digest,Law360, Private Equity Online and other prominent media outlets. Mr. Thierfelder has extensive industry experience representing clients in sectors including consumer products, defense, energy, infrastructure, retail, media and communications, healthcare, life sciences, fishing, semiconductors, manufacturing, financial services and food and beverage. As a result, he can anticipate and address industry-unique issues that often arise in the transaction process and structure the transactions efficiently.

Mr. Thierfelder is a graduate of Duke University (B.A., 1986), Rutgers University School of Law – Newark (J.D., with honors, 1992, Order of the Coif). He is a member of the New York Bar.

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Mark Thierfelder, Partner, Dechert LLP mark.thierfelder@dechert.com

pg.

Jonathan Kim focuses his practice on private equity, mergers and acquisitions, corporate finance, and leveraged finance matters. He represents strategic buyers and sellers and financial sponsors in mergers, acquisitions, and divestitures. In addition, he represents borrowers, equity sponsors, and lenders in domestic and international leveraged finance transactions in the United States and Asia, and advises on securities offerings of equity and debt.

Examples of recent transactions on which Mr. Kim has counseled include:

• Affiliates of Bregal Partners in connection with its investment in American Seafoods Group, LLC, the largest harvester of wild-caught fish for human consumption in the United States, as part of a broader deleveraging recapitalization of American Seafoods Group, LLC.

• Lumara Health Inc. in the sale of its business in two separate transactions for up to US$1.1 billion.

• Flavors Holdings, Inc., a portfolio company of MacAndrews & Forbes Holdings Inc., in connection with its acquisition of Merisant Company, a manufacturer and seller of tabletop sweeteners, including Equal®, Canderel®, and Pure Via®.

• Arbor Realty Trust in connection with its US$8 billion joint venture acquisition of Extended Stay Hotels from The Blackstone Group.

• GIC, the sovereign wealth fund of Singapore, in its US$350 million investment in Kronos Inc., a company focused on delivering workforce management solutions in the cloud, as part of a broader recapitalization of Kronos.

Mr. Kim was recently recognized as one of Legal Media Group’s Rising Stars 2015, which represents a listing of the brightest and most talented practitioners in the area of business law and related practices.

Mr. Kim is a graduate of State University of New York at Binghamton (B.S., 1999) and Georgetown University Law Center (J.D., 2002). He is a member of the New York Bar.

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Jonathan Kim, Partner, Dechert LLP jonathan.kim@dechert.com