Our previous article for Crafty Counsel touched on the importance of getting the
balance right when conducting due diligence on insured transactions with a view to
achieving the best coverage possible under a warranty and indemnity policy while
managing the costs of the diligence exercise.
As a general rule, cover under W&I policies is dependent upon an appropriate scope and
quality of due diligence, with no adverse findings.
But — what solutions are available for clients and their lawyers when due diligence
findings return known risks which would otherwise be excluded under a W&I policy?
This is where contingent risk insurance comes in.
Contingent risk Insurance
Contingent Insurance is designed to address situations where due diligence has identified a
known issue that would not be covered under a W&I policy. These risks can arise across a
wide range of areas, including litigation, regulatory exposure, contractual uncertainty,
restructuring steps or asset ownership. Unlike W&I, which provides broad protection against
unknown breaches, contingent insurance focuses on a specific, defined risk and transfers
that exposure to insurers on a bespoke basis.
For a risk to be insurable, it must be capable of legal and factual analysis and sufficiently
quantifiable.
In practice, contingent insurance tends to work best where the probability of the risk
materialising is relatively low, but the financial or commercial impact is high. A
classic “low probability, high impact” situation.
In those circumstances, insurers are often willing to underwrite the risk, even where it is fully
disclosed and well understood. Premiums are highly deal-specific, but are typically priced as
a percentage of the insured limit rather than following the more standardised approach seen
in W&I policies.
From a transactional perspective, contingent insurance is frequently used as a tool to
unblock deals that might otherwise be delayed or abandoned. Buyers and sellers can avoid
protracted negotiations around indemnities, escrows or price adjustments by transferring the
risk to the contingent insurance market instead.
This can be particularly effective on the sell side, where a known issue has been identified
during diligence. By clearly flagging the risk and presenting a contingent insurance
solution as part of the sale process, sellers can make an asset more attractive to bidders
and reduce friction during negotiations. In many cases, this approach is both faster and
more economical than traditional risk allocation mechanisms, while also providing greater
certainty for both parties.
Here are two examples we’ve recently seen in the market.
Example 1: Cartel Clawback Exposure Policy
During the sale of a portfolio company, bidders identified a known but uncertain exposure
arising from the target’s historic involvement as a whistleblower in a cartel investigation.
While only limited customer clawbacks had materialised to date, advisers noted a theoretical
downside significantly in excess of EUR100m, creating concern for buyers and rendering the
risk uninsurable under a W&I policy.
Economic analysis suggested that any realistic loss was likely to be materially lower, but the
headline exposure threatened to disrupt the sale process. A bespoke contingent risk
insurance policy was structured to sit above the expected loss and provide protection
against a catastrophic outcome. By transferring the tail risk to the insurance market, the
seller was able to reassure bidders, maintain deal momentum and ultimately complete the
transaction without reliance on escrows or open-ended indemnities.
Example 2: Secondary Pensions Liability Policy
During the purchase by a French PLC, a secondary pensions liability was discovered sitting
in the target. Historically the target business had formed part of a much larger group which
now has c.£400m pension deficit. The business unit was small when originally sold and
limited employees transferred out off the group, however the business has subsequently
grown exponentially and the present day buyer was concerned of a potential clawback by
the original group under Sec. 75 of the pensions act, or otherwise. A bespoke policy was
structured with a limit set at £40m which allowed the purchasers to feel comfortable taking
on this risk.
Conclusion
Always reach out to your broker! More and more matters are insurable now and
more so than ever, we can find solutions to any risk for our clients. This market is evolving
fast. This is also true of specific tax risks. Ultimately, by using a combination of both W&I
and contingent risk insurance, clients can ensure complete protection for any Loss arising
out of both known and unknown risks.
This article was written by Helena Eatock and Eleanor Swinburne of HWF Partners. You
can find more insights from the HWF team at hwfpartners.com/insight.
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