Mergers and acquisitions: unlocking a deal through insurance

An outstanding legal dispute, whether already in the courts or merely contemplated, can frustrate a merger or acquisition. Where the target company is facing a sizeable claim for damages, even if the legal argument or the amount claimed seems to lack merit, it can still be enough to delay or prevent a transaction completing.

In such situations, it is up to either the buyer or seller to find a way to provide the buyer with enough certainty that the financial exposure to the litigation or arbitration can be contained in order to allow the deal to proceed.

Of course that certainty can be achieved by the seller escrowing funds to cover the potential liabilities arising from the litigation, but that is not an efficient means to solve the problem for either party. The answer lies with a little known, specialist form of insurance called Litigation Buy Out Insurance (LBO), designed exactly for this scenario, reducing the number of warranties that need to be provided in the transaction and removing the need to lock up cash in escrow accounts.

An LBO policy can provide an indemnity to the target company or directly to the purchaser for the loss that arises if the litigation is successful. The policy covers the loss whether that is in the form of an award of damages that the target company is ordered to pay or legal costs incurred (both defence and other side’s costs). It is usually the cover for the damages that is of most interest and this is what sets this form of insurance apart from legal expenses products such as, Before-the-Event and After-the-Event insurance which are designed to cover the costs of a legal dispute.

An LBO policy can be purchased as an additional level of comfort to a purchaser secondary to any existing coverage (e.g., perhaps because the existing insurer does not have a sufficient rating and therefore not enough comfort to a buyer) or it can be purchased as a top-up to an existing layer of insurance cover. This might apply to disputes attached to an existing professional indemnity policy or D&O policy, for instance.

Another interesting feature of this insurance is that the policies can be arranged either before a claim is issued or after a claim has already got underway, which means it is a solution that can unlock M&A activity regardless of the status of the legal dispute holding things back. The key for the insurer is its ability to assess the prospect of the legal claim causing a loss to the target company. For that, the insurer requires a legal opinion from an expert barrister and that the target firm engages with blue chip lawyers from a respected law firm. If both are available, an LBO insurer can assess the risk quickly to meet the tight deadlines that can exist.

Each LBO policy is individually priced as the risks involved are highly case specific. If the litigation has not been started then that could lead to a cheaper premium because the insurer may factor in the chance of the claim never being brought, let alone being successful, reducing the chances of a loss. However, that does not mean that in cases where the claim has commenced premiums are always expensive because sometimes it is helpful to the insurer to see the fully pleaded claim in order to properly assess the strength of the defence. Of course, the stronger the defence, the less the insurer will charge to accept the risk.

For many legal claims, the target company may only have a partial defence. That is to say, the fact is the target company has to accept that some liability for the claim alleged is inevitable (or very likely). Where that is the case, the insurer will require its indemnity to sit on top of an agreed sum which is equivalent to the likely exposure emanating from the weaker aspects of its defence.

These policies need not be restricted to M&A scenarios as they can be used to appease stockholders generally where there is a concern that the litigation could affect the stock’s value or marketability. However, where the policy is purchased pursuant to an acquisition, the cost of the LBO insurance can often be an item that is factored into purchase price as part of the negotiations between the buyer and seller. By ring-fencing the issue causing concern with the help of an LBO policy, the existing or prospective litigation risk need no longer be a barrier to the acquisition taking place.

Example of LBO in Practice

Company A is seeking to acquire company B, but company B has a risk attached to one of its areas of business that could result in litigation. Company B has received a Letter of Claim threatening proceedings from of a third party seeking compensation of £30m.

Company A might decide there is too much uncertainty to complete the transaction or alternatively the negotiation process might become unnecessarily protracted as company A and B each seek to value the contingent liability.

By obtaining an LBO policy the buyer and seller can remove the issue and reduce the contingent liability to a fixed number (the premium plus any policy excess/retention).

Company A obtains a comprehensive legal opinion on their defence of the claim which opines that there is a valid claim for £2m but the heads of claim above that sum are weak.

Based on that advice and its due diligence, an LBO insurer issues a policy on A-rated paper covering Company A for up to £28m of damages in excess of £2m for a premium payable at the point the cover commences. The policy lasts until the conclusion of the dispute.

On the strength of that insurance policy, Company B completes the acquisition.

Company A (now owned by Company B) is ordered to pay damages of £10m. Company A claims £8m on the indemnity from the LBO insurer.


Matthew Amey is a director at TheJudge. He can be contacted on +44 (0)207 337 6034 or by email: