The economic downturn engendered by the COVID-19 pandemic likely will lead to a significant increase in acquisitions of distressed targets. Representation and warranty (“R&W”) insurance policies as well as related insurance products can facilitate these transactions. Within this alert, we discuss acquisitions of pre-bankruptcy targets, asset acquisitions from targets that have already declared bankruptcy, and potential insurance options available in connection with each of the foregoing.
Pre-Bankruptcy Targets, and Insurance for Fraudulent Transfers The process for obtaining an R&W insurance policy to cover a transaction involving a distressed target is similar to the process for obtaining an R&W insurance policy to cover a conventional transaction. As in a conventional transaction, the insurer will expect the buyer to conduct significant diligence and for the seller to provide fulsome disclosures. Insurers will pay particular attention to the target’s operations during the period in which the target experienced financial distress and will expect the buyer to thoroughly diligence whether the target complied with laws and upheld its contractual obligations while operating in financial distress. Policyholders should additionally pay close attention to the impact of exclusions relating to COVID-19, given that a distressed business would likely have operated outside of the ordinary course of business during the height of the pandemic, which could implicate a number of representations. For example, mass furloughs or layoffs could trigger not only employment representations, but representations concerning compliance with laws, the absence of certain developments since the most recent balance sheet, employee benefits, customer relationships, etc. In transactions involving financially distressed sellers, there is a risk that the seller may enter bankruptcy (either voluntarily or involuntarily) after the transaction is consummated. If that occurs, the buyer may be sued by a trustee, the seller itself, or a committee of unsecured creditors alleging that the transaction constituted a fraudulent transfer.1 If the fraudulent transfer action is successful, the subject transaction may be unwound altogether, or, more commonly, the buyer may be required to pay a judgment equal to the difference between the value of the assets it purchased (as determined by the court or jury as applicable) and the consideration the buyer provided to acquire the assets.
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Peter de Boisblanc, HUB International, also contributed to this article.