Contingent Liability Insurance: Turning Deal-Breaking Risk Into a Transactional Solution

In the late ’80s and early ’90s, I had the opportunity to develop yet another transactional insurance product in addition to representations and warranties insurance. That product was contingent liability insurance—a solution for underinsured or uninsured liabilities that were preventing the sale or purchase of companies or assets and, in some instances, inhibiting market capitalization growth and share appreciation.

Typically, in these transactions, I would incorporate non-disclosure agreements. But depending on the circumstances, the purpose of the transaction, and my confidence in the liability risk assessment of known and reported liabilities, I would conduct due diligence and assign a value to the risk.

In certain circumstances, I would allow for public disclosure of the insurance purchase. This could have the effect of raising market capitalization by alleviating the investing public’s fear that an adverse result in litigation would have a demonstrable negative impact on the company’s value. You typically don’t want to raise a disclosure red flag concerning existing litigation unless the risk has been evaluated and appropriately addressed. I used this type of contingent liability insurance structure with amazing results.

The one thing I never did was a contingent liability buyout on an unknown and unreported liability that might occur in the future, such as in the pollution or toxic tort space. The market has been punished on these kinds of transactions.

Stick to what you know, what you can due diligence, and what you can put a value on.

I worked with private equity during those years to solve transactional issues in much the same way I worked to eliminate lengthy sell-side escrows and replace them with a sell-side representations and warranties insurance product—a cheaper and less time-consuming solution for the seller.

The same principle applies to contingent liabilities.

If a private equity firm wishes to purchase an asset with a significant underinsured or uninsured liability that is holding up the transaction, the buyer can substantially discount the purchase price to account for that risk. Alternatively, the seller can provide comfort by purchasing contingent liability insurance covering the specific identified liability and allowing the transaction to proceed.

This can be a win for the seller because the reduction in purchase price demanded by the buyer may be substantially greater than the cost of purchasing insurance to address the liability. The insurance can therefore bridge the gap between buyer and seller and allow the deal to close.

Of course, the scenario also works in reverse for a private equity firm looking to sell an asset burdened by a significant underinsured or uninsured liability.

After decades of working with private equity, transactional insurance, contingent liabilities, representations and warranties insurance, and complex risk, I am here to help underwrite and due diligence these transactions, mentor professionals working through them, and serve as an expert witness when deals go sideways.