Following the publication of their white paper, Simon Radcliffe, head of GTS Claims at Liberty GTS, details recent mergers and acquisitions (M&A) insurance claims trends, and what this means for the future
Where will deals meet challenges in 2023?
Liberty GTS annually publishes an analysis of claims that have arisen on M&A deals we have insured.
The results provide real insight into how the nature of R&W claims is changing over time, and how they are likely to change in the future.
This year particularly, the macroeconomic and geopolitical environment poses numerous challenges for businesses and are likely to lend themselves to an increase in certain types of risks in the context of M&A transactions (we have identified a few of them below).
Undisclosed price increases
The built up inflationary pressures due to the supply chain issues created by COVID-19 and the disruption caused by the ongoing war in Ukraine could mean we see more claims relating to undisclosed price changes.
The risk is particularly acute if the price change is imposed on the target late in the day, just before signing, particularly in a big business.
This increases the importance of a buyer taking active steps to understand the target’s pricing arrangements with its suppliers and the contracting parties’ ability to amend the terms of an agreement or to terminate it.
We take additional comfort if we know that the buyer has been allowed to speak with key suppliers, as this will usually flush out any issues not picked up as part of the desktop due diligence.
The supply chain issues resulting from the pandemic are still not fully resolved and continue to impact businesses and their customers. This is a particularly critical issue for businesses whose operations are heavily reliant on large amounts of diverse inventory, such as the automobile industry.
Any bottlenecks that impact the speed which inventory is able to ‘move’ gives rise to potential issues around stock deterioration and obsolescence. Therefore, understanding supply chain risks remains a crucial part of the due diligence process and is a heightened area of concern.
We anticipate we could see more claims in the coming months relating to accounts receivable issues, such as the setting of inadequate bad debt reserves and errors in terms of quantifying a company’s total accounts receivables.
Indeed, one of our largest paid claims to date resulted from an allegation that the target’s management had knowingly underestimated the accounts receivable reserve, which caused more revenue to be recognised in the financial statements than management knew could be realistically collected.
We are paying much closer attention as part of our underwriting to the size of the accounts receivable figure relative to the size of the balance sheet, and asking more questions around this issue.
There is a risk the challenges presented by the current economic environment may provide target management with a greater incentive to cross the line in order to boost revenue and avoid breaching financial covenants or avoid future cash flow difficulties.
Indeed, we have already received several significant claims this year involving allegations of fraud.
The types of issues we see differ in terms of the range of sophistication: from an allegation of a local manager passing off a set of forged accounts as the audited accounts, to an allegation of a long-running and elaborate fraud around revenue recognition issues.
Rigorous forensic scrutiny applied across the entire due diligence process is the best way to avoid later complications here.
We expect to see more claims arising from environmental, social, and governance (ESG) related issues, reflecting the increased importance of this area and the reality that buyers are increasingly expecting sellers to give specific warranties on them.
The raft of associated legislation that has been or is due to be implemented will create more pitfalls for businesses and require costly new ways of working.
A business that does not keep up with these changes or fails to live up to its own ESG credentials (or ensure that its suppliers live up to theirs) will be susceptible to enforcement action or litigation, including from increasingly active action groups.