The rapid spread of the COVID-19 virus (more commonly known as the novel coronavirus) is impacting virtually all aspects of daily life, leading to significant economic disruption, including within the mergers & acquisitions (M&A) sector. While some transactions are being delayed or aborted entirely, certain transactions continue to move forward as parties seek due diligence on COVID-19 impacts on target businesses and negotiate purchase agreement terms to address COVID-19 risk. With the increased role that representations & warranties (R&W) insurance plays in the risk allocation equation in M&A transactions, clients and deal counsel are particularly focused on how R&W insurers are responding to COVID-19.
While the impact of COVID-19 on R&W insurance is fluid and continues to evolve in real time, we wanted to provide an update on some of the key impacts and market considerations we are currently experiencing in connection with placement of R&W insurance policies in relation to COVID-19 risks:
- Most R&W insurers are proposing exclusions relating to COVID-19 exposures at the non-binding indication letter (NBIL) stage. Many are including broadly worded exclusions for COVID-19, while some are taking a more targeted approach on a deal-by-deal basis. It is important to note that most insurers that are proposing broadly worded exclusions typically remain open to considering narrowing COVID-19 exclusions based on evaluation of the risks presented to the target business and the diligence around COVID-19-related impacts. Thus, insureds should be prepared to discuss specific due diligence being conducted on potential COVID-19 impacts, purchase agreement provisions that protect the insured from any related risks, and any factors that mitigate the impact of COVID-19 on the target’s class of business. Our team continues to advocate for as narrowly tailored language as possible to ensure that R&W insurance remains a viable risk allocation tool in this challenging deal environment. Examples of exclusionary language proposed by insurers include exclusions for the following categories of loss:
- Arising out of or resulting from disruptions to the company’s supply chain or operations or adverse effects on the company’s customers or other counterparties that are attributable to COVID-19 disease or the SARS-CoV-2 virus, including but not limited to (a) the failure of the company’s suppliers to timely manufacture and/or ship the company’s raw materials, (b) labor shortages, (c) government enforced quarantines, (d) reduction in customer demand, (e) reduction in the company’s revenue and/or market capitalization or (e) any related force majeure events
- Arising out of or resulting from business interruption or other losses arising out of or resulting from COVID-19
- Arising from or relating to any business interruption or other business downturn solely to the extent such interruption or downturn arises out of the coronavirus (including any resulting COVID-19 sickness) or any government or other regulatory sanctioned response thereto
- Arising out of or resulting from disruption to the target’s operations as a result of the spread of COVID-19 (novel coronavirus)
- Arising out of, resulting from or to the extent it is increased by (i) the presence, transmission, threat or fear of a novel coronavirus, including the coronavirus disease (COVID-19) or any evolution thereof, and/or (ii) any mandatory or advisory restriction issued, or action ordered or threatened, by any public authority, regulatory body or government in connection therewith including any federal, state, local or foreign regulation, rule, statute or law
- Arising out of or resulting from a suspension of or disruption to the ordinary course of operation of the company’s business (including any disputes or any impact on revenues or profitability) relating to a pandemic or epidemic disease outbreak from the COVID-19 virus or evolution thereof or any government response thereto
- Arising out of or resulting from the impact of COVID-19 or any variation thereof on the target business or any of its counterparties, including any civil authority measures or restrictions
- Arising out of or resulting from disruptions to the target group’s distribution and manufacturing operations as a result of the spread of COVID-19, including but not limited to the failure of the target group’s suppliers to timely manufacture and ship the target group’s products due to labor shortages caused by, among other things, (a) the spread of the novel coronavirus among such supplier’s employees, (b) government enforced quarantines or (c) the election by such supplier’s employees to not appear for work out of fear of contracting the novel coronavirus
- Arising from or relating to any business interruption or other impact to the extent such interruption or impact, directly or indirectly, arises out of or results from the novel coronavirus (including any resulting Covid-19 sickness) or any government or other regulatory restrictions imposed or sanctioned response thereto
- In addition to proposing exclusions, R&W insurers are carefully underwriting the potential impact of COVID-19 on the target’s business and including heightened risk commentary to NBILs. Below are some examples of commentary we have seen from insurers in recent days:
- Understanding the impact of the coronavirus on the target’s supply chain and business operations.
- Customer and supplier impacts. If COVID could affect the supply chain for a target company, or the customer demand side, we want to see diligence on it and expect buyers to be aware of such impacts, and for sellers to appropriately disclose on such impacts.
- How has the COVID-19 outbreak affected (or how will it affect) the day-to-day operations/financial and prospects of the target?
- What measures are being taken by the target for the period up to closing to protect its business/employees (including emergency work protocols, quarantines, disinfection of logistics properties, delay or cancellation of certain events/functions). Are business continuity plans for the impact of a COVID-19 outbreak in place?
- Employee availability: if a target company cannot function with employees working from home, we expect that to be understood by all parties involved and for the reps and disclosures to account for such circumstance.
- Business continuity and disaster recovery reps. We would expect these reps to be drilled down on and shown to be accurate.
- How (to what extent) have you taken into account the impact that COVID-19 has had (or may have) on the company’s business, particularly in respect of its valuation of the company — including assessment of supply chain disruption, potential contract breaches, effects on rent payments?
- R&W insurers are also paying close attention to additional representations and warranties being added to acquisition agreements to address risks relating to COVID-19 and may seek to exclude covering COVID-19 focused representations and warranties. An example of a the type of representation that was deemed excluded for purposes of policy coverage is the following:
- To the knowledge of the company, none of the company’s or any of its subsidiaries’ employees, independent contractors, or clients (i) have been presumptively diagnosed or diagnosed with coronavirus disease (COVID-19), (ii) have shown or reported symptoms related to COVID-19, or (iii) have had any contract or other interaction with any person who has been presumptively diagnosed or diagnosed with COVID-19 or who has shown or reported symptoms related to COVID-19.
- M&A agreement provisions around issues such as determination of a “material adverse effect,” representations around “absence of changes” provisions, and interim period operating covenants will undergo increased scrutiny by R&W insurers, with heightened concern over potential COVID-19 impacts. This will be magnified on transactions with longer contemplated interim periods, and it will be important to effectively negotiate the mechanics with the R&W insurer on each transaction.
- On deals currently in the interim period, depending on the timing and nature of the target business, insurers are more frequently asking questions on bring-down calls to determine what steps the buyer has taken to understand the impacts that COVID-19 has had on the target’s operations, facilities, employees, suppliers and supply and distribution chains, material customers, IT systems and other matters. As “interim breaches” (i.e., breaches that first arise and are discovered by the buyer in the interim period) are often excluded under R&W policies, insurers are seeking to understand what is “known” by the buyer prior to closing.
Overall, R&W insurers are moving in real time to develop underwriting protocols to address COVID-19-related risks in M&A transactions, and our transactional risk team at Willis Towers Watson will continue to work closely with our clients, their counsel and the insurance market to proactively address these new challenges, as parties negotiate M&A transactions with a focus on maintaining the effective use of R&W insurance as a risk allocation tool in this rapidly changing environment.
Each applicable policy of insurance must be reviewed to determine the extent, if any, of coverage for COVID-19. Coverage may vary depending on the jurisdiction and circumstances. For global client programs it is critical to consider all local operations and how policies may or may not include COVID-19 coverage. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal and/or other professional advisors. Some of the information in this publication may be compiled by third party sources we consider to be reliable, however we do not guarantee and are not responsible for the accuracy of such information. We assume no duty in contract, tort, or otherwise in connection with this publication and expressly disclaim, to the fullest extent permitted by law, any liability in connection with this publication. Willis Towers Watson offers insurance-related services through its appropriately licensed entities in each jurisdiction in which it operates.
