Law Firm Confidential Agreement

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					                                              Financial Solutions

Insurance Issues In Transactions
The Intersection of Transactional Risk Insurance
& Lawyers Professional Liability Insurance
 Spring Meeting - Dallas
 ABA Section of Business Law
 April 10 - 12, 2008

  Presented by:

  Gary P. Blitz, Esq., Managing Director
  Aon Financial Solutions
  Tel:    212-441-1106/DC Tel: 202-429-8503
  Cell:   301-704-4640

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The Intersection of Transactional Risk
 Insurance & Lawyers Professional Liability
       – Overview of Insurance products available in mergers
         and acquisitions, private equity and other corporate
         transactions; Case studies
       – Law Firm‟s Role in Underwriting Process
       – Negotiated Protections
       – Next phase – Insuring the Law Firm

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          Overview of Transactional Insurance

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Transactional Insurance Solutions

    Broadly Applicable                 Specific Issues

                                         Tax                         Tax Insurance
        Representations &
           Insurance                    Pending                          Litigation Buyout
                                       Lit/Known                             Insurance

          Buyer               Seller                              Environmental Liability
                                       Pollution                       & Cost Cap

                                        Other                       Special Situation

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         Representations & Warranties Insurance –
                              Premium/Transaction/Loss Information

 Information is anecdotal and incomplete. 2007 info. Is
 Est. 600 - 650 R&W policies underwritten in US to date
 In 2007, US market estimate for 5 active markets (up from 3 in
  2006) is 70 R&W policies (up from 60 policies +/- in 2006)
  (Total internationally is approx 200+ policies)
 2007 est. US premium is $65-70M on R&W alone.
 Average R&W ROL in 2006 – 3 - 4% in US
 Paid claims by active underwriters continue to be minimal;
  some insurers have had none
 Early experience associated with extremely low attachment
  points NOT experienced by currently active underwriters

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               Representations & Warranties Insurance
                  Claims Experience (Aon Clients)
   • Aon‟s Private Equity & Transaction Solutions group has been informed of 17
     claims made with respect to Reps & Warranties policies it has placed.
                              » Of those 17 claims, five ultimately settled or resolved within the applicable
                                policy retention.
                              » Four of those claims exceeded the retention, and resulted in millions of
                                dollars in payments to insureds.
                              » Eight claims remain open and are at early stages in the claims process.

   • While hesitant to release specific claims data, Insurers confirm payment
     of claims, with one large insurer recently paying half of a R&W policy limit
     (approx. $5 million) for breach of an IP representation.

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                Representations & Warranties

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Representations & Warranties Insurance
                                              Elements of Merger
   Seller makes statements regarding the business being sold                     Reps & Warranties

   Buyer wants financial recourse against the Seller if statements                 Indemnification
   aren‟t accurate & buyer sustains a loss

   Seller seeks to:

               • Limit the length of time it‟s on the hook for breaches       Survival Period of R&W
                 of R&W

               • Define the maximum amount of the indemnification                     The Cap

               • Make sure the Buyer pays a minimum amount before
                 requesting indemnification                                          The Basket

   Buyer wants security that there will be financial resources to back
   up Seller‟s indemnification obligations
                                                                                    R&W Policy
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Representations & Warranties Insurance
     Reps & Warranties are usually backed by Indemnification Obligation
            Limited or unlimited in dollar amount
            Limited in time
            Applicable if loss exceeds threshold amount
            Not all Reps & Warranties necessarily covered

     Indemnification Obligations traditionally backed by Security
            Escrow
            Equity hold-backs
            Deferred or contingent purchase price payments
            Legal, Accounting, Solvency and/or Tax Opinions
            D&O, E&O and/or Other Insurance
            Hold Harmless provisions
            Letters of Credit
            Surety Bonds

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Representations & Warranties Insurance
     Buyer vs. Seller Coverage
            Transaction structure
            Impact on Knowledge exclusion

     Insurance May Cover:
            Single, multiple or full complement of representations (20+ pages)
            For example ….
                    Compliance with Tax Laws
                    Intellectual Property Matters
                    Product Liability Issues
                    Financial Statement /Accounting and Finance Issues
                    Employment Practices, ADA, EEOC matters
                    ERISA
                    Environmental Liabilities
                    Regulatory Issues (e.g., compliance with franchise laws)

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Representations & Warranties Insurance
     Why buy R&W Insurance
             Bottom line – increase liquidity to seller by requiring seller to leave less on the
             Extend survival period to buyer without expanding seller‟s liability
             Protect against financial statement fraud
             Increase maximum indemnity without expanding seller‟s liability
             Reduce seller deductible without expanding seller‟s liability
             Eliminate risk at a known cost
             Allow parties to focus on the “guts” of the transaction
             Move parties to successful closing

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                      Representations & Warranties Insurance
                                  Insurance to supplement 1-Year survival
                                         $200 Million Transaction
                                                     Risk Transfer Insurance

       $5M                     Term for Most Reps 3 Years      Tax, ERISA, Envtl Reps – 6 Years

       (1%)               Buyer

                         Year            Year         Year      Year         Year            Year
                          1                2            3        4            5               6
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Representations & Warranties Insurance
                                *Seller Coverage*
    Publicly-traded financial services company selling a subsidiary (valued at $200M) to a U.S.
     financial institution.
    Announced sale of remainder of seller slated for 6-12 months later.
    Seller negotiates $40 million indemnity cap for many representations (with 1 year survival). Buyer
     insists that indemnification on a few representations remain uncapped with survival to statute of
    Buyer also requires guaranty of main shareholder due to pending sale of seller.

    Aon structured and negotiated a “Sellers” Representations & Warranties Policy to respond up
     to the $40 million cap and beyond the 1 year survival period on reps open to the statute of
    $40 million limit; $2 million retention; 7 year period; overall premium 5% of limit purchased

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Representations & Warranties Insurance
                                *Buyer Policy*
      Sale of widely held private US manufacturing company for $200 million
      Seller‟s Board sought structure like a private deal with only one-year survival on all
       reps and warranties and a cap of $50 million
      Buyer required survival for statute of limitations for title, tax, Erisa and
       environmental reps and 3- years on all others
      Negotiations were at an impasse

      Representations & Warranties Policy provided coverage against breaches for
       survival periods required by seller and topped up amount in first year
      Policy term: 7 years; premium approximately 4% of maximum limit
      Year 1: $10 million limit/$40 million retention
      Years 2-7: $50 million limit; $5 million retention
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               Tax Opinion Insurance

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Tax Insurance

         Tax Liability or Tax Opinion Insurance can help
         a company reduce or eliminate an unwanted or
         contingent liability arising from a successful
         challenge by the I.R.S. and/or other tax
         authority of a company‟s tax treatment of a
         current, pending or historical transaction or

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Tax Insurance
 Common Features
            Insuring Clause – Specified Transaction and Intended Tax
             Treatment (Federal, state, local and/or foreign)
            Coverage – Legal Risk (comparable to PLR)
                •   Tax, interest, penalties, contest costs and/or gross-up
            Representations and Warranties by Insured
            Policy Term
            Co-insurance
            Contests/Claims
                 Who pays Contest Costs?
                 Right to Associate Language
                 Defense and Settlement Authority/Consent
            Limited Exclusions

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Tax Insurance
      Why Buy Tax Insurance?
                Alternative to Private Letter Ruling
                Confidentiality
                Allocation of Economic Risk of Tax Loss
                Remove a Transaction Issue
                Security to Transaction Counterparty
                Credit Rating of Indemnitor
                FIN 48 (FASB Interpretation No. 48 – “Accounting for
                 uncertainty in Income Taxes”)

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Tax Insurance
Subject Matters
For example …….
 Tax-free Reorganizations                   Tax     Shelters
 Section 355 Spin-Offs

 Tax-free Mergers
 Partnership Issues

 Employee Benefits Issues
 Section 280G Golden Parachute Issues
 Real estate acquisitions/sales

 NOLs

 Tax Credits (Synfuels, Low Income Housing, etc.)

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Tax Insurance -- Tax-Free Spinoff

       Public Company tax-free spinoff of “C” corporation division and merger into a
        publicly-traded REIT.
      • Approved by shareholders, subject to private letter ruling from IRS.
      • Potential tax liability about $1 billion.
      • IRS declined to rule citing concern over other taxpayer‟s exploiting the precedent.
      • Seller‟s Board does not want to revisit transaction with shareholders.

      • Tax Opinion Policy used to insure against IRS challenge.
      • $500+ million limit; no retention; 7 year period; $25 million premium.
      • Note: In current market, available capacity may be less.

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                Tax Insurance – UK Restructuring
      US private equity fund was considering the purchase of a US company with
       operations in the UK and Europe. Several US companies were embedded within
       the UK part of the corporate group.
     • Buyer wanted to rationalize the corporate structure, and planned to reorganize in
       a manner that would be tax free in the UK (pursuant to the substantial
       shareholdings exemption).
     • Buyer‟s tax advisors believed the transaction should be tax-free, but Buyer was
       reluctant to proceed due to the magnitude of the risk (120% of equity invested)
     • Seller refused to indemnify the buyer for this risk.

      • Tax Opinion Policy used to insure against HMRC challenge.
      • GBP75M (US$150M) limit; 5% coinsurance; small retention; 90 month period;
        $10M premium.
      • Note: Three difficulties which were overcome: No written advisor work product; 12
        month waiting period before reorganization could be completed requiring
        extended policy term; and extreme pressure to close timely by seller.

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                              Financial Solutions

 Litigation Buyout Insurance

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Litigation Buyout
    What is Litigation Buyout?
       A Litigation Buyout Policy (LBP) is a specially
       designed insurance policy which affords coverage for
       past, current, or prospective litigation and claims
       which are either uninsured or underinsured.
       The LBP Can Be Structured to Cover:
                 Defense Costs
                 Settlements, Judgments and Defense Costs
                 Judgments Only

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Litigation Buyout
Think Different

                                   Conventional                             Litigation
                                    Insurance                                Buyout
                                     Program                                Program

                                   Conventional                         Litigation Buyout

                                 Unknown Events                       Known Loss
                                 Prospective Coverage                 Retro Cover
                                 Off the Shelf Policy                 Customized Policy
                                                                       May Combine Aspects of
                                                                        Conventional Insurance

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                                                  Different = Opportunity
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Litigation Buyout
    Insurance Coverage is Available for the Following:

         D&O, E&O, EPL, Fiduciary
         Products Liability
         Environmental/Asbestos
         Intellectual Property
         Casualty and X/S Casualty
         Tax
         Other (unlimited potential)

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Litigation Buyout
Common Features of an LBP
   Broad Coverage
   Insuring Clause = Specified Litigation or Claim(s)
   Limited Exclusions
   Hammer Clause
   Co-Insurance
   Premium Adjustments
   Claim Control Provisions
            Right to Associate Language
            Defense and Settlement Authority/Consent
            Claims Committee

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Litigation Buyout

        New LBP               $200 million   Key Features
                                                Wall Street, regulators,
                                                 doctors, etc., all appear
                                                 satisfied with LBP
                                                Stock up 200% within one
                    SIR       $125 million       year
                                                 of LBP placement
                                                SIR & co-insurance (see
 Existing D&O Policy          $50 million        shaded area) designed to
      (4 Layers)                                 maintain proper incentives

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Litigation Buyout

                                                                  Key Features
                                                                     University won $30mm
                                       $30 million limit
            New LBP                                                   but faced possible loss on
                                                                     LBP „locked in” win
                                                                     Extremely cost-effective
                                                                      compared to structured
   No Existing Policy                                                 settlement and other
              Update – State Court of Appeals voted 8-0 against client. Insurer paid near total loss.

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Law Firm’s Role in Underwriting Process

   Insurer‟s generally hire outside due diligence counsel
   Assignment is to do a “second review”
            Did client‟s firm look in the right places? Raise the right
            Did client instruct counsel as it would in the absence of
   Due diligence reports (in R&W case) and
    opinions/memos (in the tax/special situations case)
    provide a road map
   Insurers are not seeking to rely on or create a right of
    subrogation against client‟s advisors

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Law Firm’s Role in Underwriting Process
Sample Due Diligence Request – R&W Insurance (Source:AIG)
        Draft acquisition agreement and related disclosure schedules;
        Financial statements of the seller and the acquired company or acquired
        Any offering memorandum or other informational materials prepared in connection
         with the transactions contemplated by the acquisition agreement;
        Any proxy statement or information statement prepared in connection with the
         transactions contemplated by the acquisition agreement;
        Buyer's due diligence request list and responses thereto, if in writing;
        Data room index or other due diligence document index prepared in connection
         with the transaction contemplated by the acquisition agreement;
        Third party reports, studies or opinions ;
        Working group list; and
        Transaction timeline.

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Law Firm’s Role in Underwriting Process
Are Firm’s Protecting Themselves?
         Big 4 are more vigilant than law firms

              Before even oral discussions

              Possibly too aggressive?

         Protections

              Waiver/nonreliance letters

              Waiver of subrogation

              Limitation of liability (UK – insurer market counsel)

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Law Firm’s Role in Underwriting Process
Are Firm’s Protecting Themselves?
              Sample Subrogation Language – 2007 tax insurance
               “If the Insurer makes any payment of Loss under this Policy in
               respect of a Loss, the Insurer shall be subrogated, to the
               extent of that payment, to all the rights and remedies of the
               Insured in respect of that Loss, . . . . and the Insurer shall be
               entitled at its own volition to sue any parties other than the
               Insured and its affiliates in the name of the Insured, provided
               that the Insurer shall not have any rights of subrogation
               against (i) [Big 4 accounting firm], (ii) [Buyer’s Am Law
               100 Law Firm] and [Seller’s Am Law 100 Law Firm] or any
               direct or indirect equity holder of the Insured Companies
               (except for intentional misconduct and recklessness). . . .”
               [emphasis added]

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Next Phase – Insuring the Law Firm for
Transaction Specific Risk
              350 Lawyer Firm maintains $50M aggregate limit of
               professional liability insurance
              Client engages firm to write an opinion on the Federal tax
               treatment of the “tax-free” spin-off of a $5B division. If the IRS
               challenges the tax treatment and succeeds there will be tax at
               the corporate and shareholder levels > than $2B.
              Firm determines that it would be prudent to have higher limits
               of insurance given the potential liability should there be claims
               relating to the tax opinion work.

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Next Phase – Insuring the Law Firm for
Transaction Specific Risk
Options to Firm
              Purchase excess LPL insurance limits [traditional response]
              Purchase a special purpose LPL policy
                         Dedicated limit for specific transaction and lawyers working on
                          that matter
                         Possible structure – 1-2 year policy which can be converted to a
                          tail through the end of the statute of limitations
              Client purchases a tax indemnity policy
                         Eliminates economic damage to transaction parties
                         Law firm obtains nonreliance letter from insurers or waiver of

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Next Phase – Insuring the Law Firm for
Transaction Specific Risk
Some Considerations
              Who bears the cost?
              Traditional LPL coverage is annual, but transactional based
               responses can be tied to the relevant statute of limitations and
               charge a one-time premium
              Tax insurance just requires a bad result; LPL insurance
               requires an error or omission & a claim vs. the law firm
              An LPL based response may be a narrow risk for insurers and
               should attract greater limits at a lower cost
              Others?

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                              THE END


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