Covid-19 Underwriting Implications for W&I

The current M&A landscape is fraught with uncertainty. There can be no doubt the outbreak of Covid-19 has impacted the majority of M&A transactions globally and not just in Europe where Ascent provides warranty and indemnity insurance. For the last two weeks we have seen a number of deals go on hold or fall over completely. Given the realities of what we are faced with, this can only be expected. In addition, over the last few weeks we have been asked by stakeholders across the business how we are dealing with the potential impact of Coronavirus on transactions which we are insuring.

In short, we will not be applying a specific Covid-19 exclusion within our policies (naturally, any specific warranties or indemnities will be struck out in the usual way). Instead, and as always, we will work with Insureds and take our comfort from the transacting parties and what they know about the businesses they are either acquiring or selling, and their ability to evidence this during underwriting. That being said, there are areas that should be known about a target business in the current climate that perhaps were less significant or business critical just three months ago. Below we set out the issues we think are relevant to underwriting transactions during this period.

Accounts/Financial Statements: An obvious one we know, but accounting assessments will now have different considerations given the number of businesses whose accounting date ends in the throes of this Covid-19 outbreak. Below, are the areas we’d expect closer attention to be paid in any prospective transaction:

• Going Concern – Cash flow is king. The question of whether there is enough cash in the business to sustain the next 12 months is vital. In preparing the accounts, a key consideration of the management team is the ability of the business to continue as a revenue and (hopefully) profit making entity, or “going concern” in standard accounting vernacular. Whilst the going concern designation is always an assumption, prospective buyers and management teams will need consider the impact of coronavirus on their business and the uncertainty it creates, and more importantly whether the going concern assumption is now reasonable. Of course, there is not a one size fits all approach that needs to be applied and most circumstances will be different. As the crisis starts to unfold, it is likely that any judgements made throughout the outbreak and diligence period will need to be regularly reassessed.
• FVM – Fair Value Measurement (or FVM) is the required standard for the measuring of most assets and liabilities on a company’s balance sheet. The ultimate aim being not to inflate or deflate the price of those assets (or liabilities), instead to value them in the present light of day using considerations of other relevant would-be market participants i.e. what value should be placed on these items during the current market amid the Covid-19 outbreak. As a result of the coronavirus outbreak, we would anticipate a greater level of scrutiny being placed on these balance sheet items during the diligence process to test whether the impact of the outbreak played a role in the fair value being shown in the accounts. We do not believe that balance sheets will be deliberately misrepresented as a result of the outbreak, although, it is entirely possible the underlying assumptions were not appropriately adjusted to reflect current and prospective trading conditions. 
• Government Support – the UK Government has unveiled an unprecedented support package to help boost and stabilise the economy, with many other European nations also doing the same. Though still pretty unclear as to how these measures will be implemented, what is clear is that there is no shortage of businesses that may need some additional assistance through this crisis. Whilst the government assistance will come as a great relief, it won’t be without its headaches. Businesses will undoubtedly have to navigate a number of different and potentially new accounting policies….especially with respect to Tax. What will be most important for buyers is to understand what impact these measures have had on the business and what it will look like once they’re taken away. As always, we will want to see that the buyer has a firm understanding of what the target looks like going forward.  

To the extent the transaction is being undertaken halfway through the financial period we would expect an increased level of disclosure with respect to accounts warranties, especially those relating “No Material Changes since the Accounting Date”.

Contracts: There is currently a lot of thought being given by some as to whether the Covid-19 outbreak would constitute a force majeure or lead to total contract frustration. The reality of it is, that the majority of businesses will suffer difficulties with cash flow due to the inordinate stressors that Coronavirus is placing on their operations. Whilst hopefully short term, the impact will be great and likely to be felt/noticed by the businesses’ contracting parties. It may be that they have to change the basis on which they have originally contracted, push deadlines and rethink the wheel of their day to day operations (much in the same way we all have). For some this might actually mean falling foul and not fulfilling their obligations under their material business contracts and even breaching loan covenants as cash flow and revenues continue to be restricted. These alterations to the status quo need to be understood during the transaction process and what the route back to normal operations looks like.

HSE and Employees: Admittedly the Transaction Liability market has never taken on much in the way of environmental liability, but compliance with health and safety obligations has always been fairly standard. Whilst we hope this will continue to be the case, we will want to see evidence of how prospective targets have complied with these obligations during the outbreak, particularly in relation to their employees. It will be necessary to see that they have continued to comply with their obligations during working from home periods, which now seem set to last much longer than we may have envisaged.

The above is by no means an exhaustive list of considerations but rather issues we see likely to play out over the duration of the Coronavirus outbreak. Whilst the situational issues may be novel, the fundamentals remain the same. We welcome parties’ taking their time during this period; not rushing to complete, and instead, exercising caution to fully assess the deal against the backdrop of this current situation.

Ascent is here to provide any advice that we can to help you through the current situation . We will strive to ensure that all of our broker partners and clients emerge in the best possible position as we emerge from the Covid-19 crisis.