July 2021 Issue
FW discusses contingent risk insurance with Andrew Mutter and David Barnes at CAC Speciality.
FW: What kinds of risks may be offset by contingent risk insurance (CRI)? Are there any common elements to the risks that you have seen that make them executable?
Mutter: Most insurance products focus on unknown risks, while contingent risk insurance (CRI) is focused on insuring known risks of a legal nature. And there are four categories these legal risks usually fall into: exposure from defence-side litigation, potential gain from plaintiff-side litigation, successor liability from potential claims not yet brought against the purchaser of a business, and potential regulatory or contractual exposure if the interpretation of the current legal position is challenged by an agency or third party. So, it may be a patent case you are currently litigating against a competitor who has infringed on your IP, or you may have an aggressive plaintiff claiming you owe them hundreds of millions of dollars, and it is complicating your credit or investor relations, or you may be very confident that you will secure appropriate permitting for a major construction project, but there is the possibility of an interested party bringing a challenge. These would all potentially be insurable risks.
Barnes: The other key elements common in insurable contingent risks are that the risk is truly low probability, there is usually a non-risk related motivation for wanting the insurance, and the facts are reasonably well established. Carriers are worried about selection bias – that is, they are worried that a party is going to seek to insure only a risk that it is truly ‘worried about’ and, in those instances in which the risk is truly remote, then the party will just bear the risk itself rather than pay the premium. So, an M&A deal or some other non-risk related reason to shift the risk is often key.
FW: Bearing in mind that this solution is not exclusive to M&A, in what situations have you found CRI most actionable and valuable?
Mutter: Going back to the examples of an IP claim against a competitor, a nasty lawsuit you are defending, or the permitting challenge, the common element of what makes them actionable and valuable is that there is a powerful strategic reason for why the policyholder would greatly prefer not to wait to see how the contingent liability or asset plays out over time. In the IP litigation, for example, you may have had a successful judgment worth over $100m, but you know that it is going to take you years of appeals and potential remands to actually receive that amount. In the meantime, your company could really use the capital now for M&A or organic growth. Insurance can provide certainty that, at a minimum, you will receive at least a substantial portion of the judgment, and we will then work with lenders on the basis of that insurance policy to provide very attractive essentially non-recourse financing. Or in the defence-side example, if you are trying to sell your company, or set up a new debt facility, the pending litigation can seriously impair the terms and value you would receive if that contingency was more certain. Finally, in the permitting example, you may need to set up project financing and get the process moving while permitting is not yet resolved, but banks are not willing to engage unless there is more certainty around the potential challenge. Bottom line: do you have a reasonably low, but uncertain, legal risk and a strategic need for certainty? If so, insurance can provide that certainty.
“Competition and interest has been fantastic for clients. Market appetite is expanding, and the use of the product is growing exponentially.”
FW: In an M&A transaction, what are the benefits and strategic advantages of utilising a CRI solution for both the buyer and the seller?
Barnes: This may come as a shock to a lot of M&A lawyers, but buyers and sellers often have very different opinions of the likelihood that a known, identified risk will occur and the potential financial impact of that risk should it occur. In certain instances, sellers preparing for an auction must wrap a remote, but known risk, with an insurance policy to avoid having the issue come up in diligence. In other instances, the sellers and the buyer just cannot agree on a feasible solution for a risk, such as an escrow. CRI is, in effect, a neutral third party pricing out a particular risk. And it often allows deal parties to get over an issue where they have been unable to see eye-to-eye and get a deal done that might otherwise die. And, for sellers preparing for an auction, it often takes an issue off the table that will inevitably become an issue in diligence.
FW: In what ways has CRI been utilised in M&A transactions since the onset of the coronavirus (COVID-19) pandemic?
Barnes: The COVID-19 pandemic put the development of the CRI market into overdrive. Representations and warranties (R&W) insurance placements plummeted in the spring and summer of 2020, and carriers and brokers were looking at other ways to add value to their clients. Additionally, a good number of the deals that were moving forward during this time involved distressed transactions or deals that were otherwise not perfectly ‘clean’. As a result, they spun off a lot of potentially insurable contingent risks. During this time, a number of new products came to market which could add value to parties, such as the Paycheck Protection Program (PPP) insurance programme that helped borrowers lock in the value of their PPP loans. There was also a significant uptick in parties exploring judgment preservation policies – particularly on the plaintiff side. Overall, the pandemic resulted in carriers from around the globe getting into this market to supplement their dwindling R&W insurance book. Carriers have hired full-time contingent risk underwriters and are actively chasing deals. That competition and interest has been fantastic for clients. Market appetite is expanding, and the use of the product is growing exponentially.
FW: What advice would you offer to buyers and sellers on purchasing contingent risk coverage that helps to facilitate a deal and move it toward close?
Mutter: If you know you have a material legal risk and are considering selling, make exploring CRI an immediate priority. A lot can be done with the insurance policy to help resolve deal friction and give you better terms as a seller. CRI can be used well before a seller has gone to market to attract the maximum interest and best terms from buyers from the get-go.
Barnes: The market is continuing to improve in its response time, but each of the risks is unique and takes substantial time to review and potentially quote. Each policy is bespoke and must be negotiated to wrap the particular risk at issue. Insurers can move fast, as can markets, but it certainly does not happen overnight. Also, buyers and sellers should not assume something is uninsurable simply because it does not perfectly meet the criteria set out here. Just because your risk is early stage or fact dependent, do not simply assume it cannot be done.
“If you know you have a material legal risk and are considering selling, make exploring CRI an immediate priority.”
FW: Looking ahead, what are your predictions for CRI in M&A deals? Do you expect to see an increase in demand?
Barnes: The entire contingent risk market is expanding. A lot of deals that were viewed as too complex or too early stage are now getting done. Carriers have hired full time contingent risk underwriters and they better understand the risks we are asking them to take. Just like R&W insurance and then tax insurance, we view this as a building snowball. The more policies that get placed, the more flexible and adaptable the product will become. And the more deal lawyers and M&A buyers and sellers get familiar with and use the solution, the more the market will grow. We think we are just at the start of this.
FW: What are your predictions for how CRI will continue to be used in non-M&A contexts?
Mutter: We think the opportunity for non-M&A contingent insurance is nearly limitless. A pending M&A deal is just one of a potential host of strategic reasons why you would want to either lock in a portion of the value of an existing legal claim or cap the potential exposure in a legal dispute or an uncertain legal position. CRI can be used to protect a legal uncertainty in a significant investment, monetise a legal asset or portfolio of assets, enhance terms and credit in a debt facility, manage the risk that despite best efforts to comply with a specific regulation, interpretation of that regulation could change or be challenged, and so on. The more that companies, private equity firms, lawyers and investors understand how CRI works and how effective and reliable it can be, we will see the solution used in a variety of creative problem-solving ways.
Andrew Mutter is a senior vice president at CAC Specialty, LLC. He specialises in using bespoke insurance solutions to shift known legal risks and, together with his colleagues, has placed over $1bn of contingent risk limits into the insurance markets. Before becoming a broker, he was a complex commercial litigator with a focus on bet-the-company litigation and insurance recovery for large corporate policyholders. He graduated from the University of Virginia School of Law, where he received the James M. Shoemaker Moot Court Award. He can be contacted on +1 (423) 718 5273 or by email: andrew.mutter@cacspecialty.com.
David Barnes is a senior vice president at CAC Specialty. During his time as a broker, he has used insurance solutions to shift known legal risks and, together with his colleagues, has placed over $1bn of contingent risk limits into the insurance markets. Before his insurance career, he was an appellate litigation specialist, where he litigated cases before every US federal appellate court including the US Supreme Court. He graduated as valedictorian from Vanderbilt Law School. He can be contacted on +1 (404) 360 8167 or by email: david.barnes@cacspecialty.com.
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