Developments in transaction insurance: reverse termination fee insurance

 
A new insurance product—reverse termination fee insurance—has recently emerged for use in the U.S. and Canada under which M&A parties can insure the risk that a reverse termination fee becomes payable under an M&A agreement as a result of regulatory issues. Although relatively new in the market, policies have been written to insure RTFs payable in connection with failure to obtain approval from the Federal Trade Commission, CFIUS, Investment Canada and state public utilities commissions. (To date, RTF insurance is limited to reverse termination fees associated with failure to receive required approvals, and we are not aware of insurers offering to underwrite RTFs associated with a financing failure.)

Benefits

The value proposition for RTF insurance operates on several levels. Sellers may perceive more regulatory risk than buyers, and accordingly demand an RTF that is larger than a buyer can commit to, even in light of the buyer’s perception of lower risk levels. A seller may also have concerns about a buyer’s ability to pay an RTF and demand guarantees that the buyer cannot provide. In the private equity space, this may take the form of seller discomfort with private equity structures and a demand for guarantees from buyer-affiliated entities that cannot provide them. RTF insurance “bridges the gap” between buyer and seller on risk concerns and can assuage creditworthiness concerns.

How it works

The process for obtaining RTF insurance is similar to the representations and warranties insurance process. The insurance broker works with the buyer and its counsel to provide the insurer with a substantive analysis of the risk. In some instances, counsel or experts may provide assessments or reports to the insurer. The thoroughness of the buyer’s analysis of regulatory risk may affect the underwriting and the premium. Insurers will also provide input on the “regulatory efforts” covenants in the acquisition agreement, which set forth the buyer’s obligations to take steps to obtain regulatory approval in the face of regulatory opposition. The weaker the obligations of the buyer, the higher the premium the insurers will demand.

Significantly, for a buyer to collect under an RTF policy, the buyer must comply with the regulatory efforts covenants under the acquisition agreement. Buyers are also obligated under RTF policies to provide the insurer with the right to review and consent to certain correspondence with regulators and, in some circumstances, to litigate against regulators to a final judgment in the event of an enforcement action (although buyers can sometimes pay an additional premium to reduce the obligation to appeal/litigate). These policy requirements may make RTF policies unattractive for “repeat players”, such as serial acquirors who appear before the same regulators on multiple occasions.

From a pricing perspective, brokers peg the premiums for RTF insurance against antitrust risk at 5-10% of the insured amount of the reverse termination fee, while insurance against national security (CFIUS) risk is a bit higher, at 10-15% of the insured amount. However, given the newness of these policies, we would expect premium costs to eventually drift downward if RTF insurance is more widely adopted, as insurers get more underwriting experience with the product and new participants enter the market.

Conclusion

RTF insurance appears to be an interesting innovation in the field of transaction insurance available in M&A deals, although current pricing levels do not suggest that RTF insurance will be widely adopted in the near term. However, as a niche product for bridging risk perception or credit perception gaps on particular transactions, its emergence serves to provide a helpful option in the toolbox for dealmakers.