Transactional insurance provides a buffer for mergers and acquisitions risks

No matter how thorough the due diligence is prior to a merger or acquisition, sometimes deals go awry, such as when the post-acquisition revenue falls short of projections or the buyer incurs successor liability exposures such as unpaid income taxes or undetected environmental contamination.

Such complications can be especially hard on middle-market companies, which today are investing more of their own capital into mergers and acquisitions to ensure the investments yield attractive returns, sources say.

While M&A activity may have slowed during the first half of 2013, dealmakers expect an uptick in the second half as the economy improves, according to a recent online poll by Deloitte L.L.P., the New York-based firm that provides audit, financial advisory, tax and consulting services.

Though transactions in the middle market — valued at $1 billion or less — dropped 5% in this year's second quarter from the first quarter, 76% of the 1,800 professionals responding to Deloitte's survey in May said they were significantly optimistic about the M&A market for the remainder of the year.

As deal activity picks up, there is often a concurrent uptick in post-transaction litigation alleging misrepresentation. However, there are transactional risk insurance products to mitigate these post-acquisition exposures, often obviating the need to a file a breach of contract suit.

“In most purchase and sale agreements, the seller is going to make representations about the business,” said Kevin Maloy, senior managing director at Crystal & Co. in New York. “These include disclosures of all known liabilities, that the business is in compliance with state and federal tax regulations, isn't violating any environmental laws, that its insurance is adequate. The buyer, in turn, may ask to be indemnified for any unintentional breaches of those representations.”

This request can be satisfied either by depositing funds into an escrow account that can be used to indemnify the buyer for any liabilities that arise after the transaction, or through the purchase of transactional risk insurance, he said.