In recent years, a very sophisticated product has burst onto the Spanish M&A market: Litigation Risk Insurance (LRI). More and more companies involved in mergers and acquisitions are taking out this type of insurance to cover the costs associated with litigation that may arise from the transaction.
Types of M&A insurance
In M&A transactions, insurance is increasingly used as a tool to protect the parties involved in the transaction against the risks associated with the transaction. By taking out specialised M&A insurance, it is possible to transfer some of the risks arising from the transaction to an insurer.
Until recently, insurance was reserved for large M&A transactions, but in recent times it has become popular even for transactions with a value of less than EUR 50 million.
These are the types of insurance we most commonly recommend in the M&A transactions we advise at Confianz:
- Representations and warranties insurance: This is the most common and is usually used to cover costs and damages resulting from the possibility that one party is untruthful or inaccurate in the representations and warranties it makes to the other party.
- Litigation risk insurance: Covers the costs associated with litigation that may arise from the transaction. This is the type of insurance that we will discuss in depth in this article.
- Environmental contingency insurance: Covers costs arising from environmental risks that may materialise in the transaction, such as soil or water contamination.
- Fraud and embezzlement insurance: Covers the risks of fraud or embezzlement by the management or employees of the acquired company.
Types of M&A litigation insurance
There are three types of litigation risk insurance:
- Adverse Judgment Insurance. In exchange for a premium, it guarantees that, if there is a conviction, the insurance pays out. In this way, the provision can be removed from the balance sheet.
- After The Event Insurance or Costs Compensation Insurance. It may even cover the costs of the lawyer.
- Judgment Preservation Insurance, Judgment Preservation Insurance or Contingency Insurance. When a judgement has already been passed, if this judgement is overturned in the second instance or by the Supreme Court, the insurance pays 80-90% of the amount of the sentence. A typical example would be a provincial court sentence that condemns a party to pay 10 million euros. With a Judgment Preservation Insurance policy the plaintiff can insure a large part of that 10 million euros. In other words, if the Supreme Court overturns the judgement and annuls the judgment, the insurance would pay, for example, 8 or 9 million euros to the plaintiff. If the Supreme Court judgement reduces the sentence to 5 million, the plaintiff would receive 5 million from the opposing party and 3 or 4 million from the insurer. However, this insurance does not cover the possible insolvency of the debtor.
Conclusion
Litigation insurance premiums often have a very high cost that is usually not affordable. It is also important to bear in mind that the insurance will not cover all risks, and there may be exclusions and limitations in the policy. Highly complex clauses need to be negotiated. For these reasons, it is advisable to seek advice from M&A lawyers.