Crystal ball gazing aside, various micro and macroeconomic trends suggest that the hot merger and acquisition market in the food and beverage industry will continue in 2016 and beyond. These trends include industry consolidation, an increasing consumer demand for healthy alternatives, and favorable credit markets. Considering some of the unique aspects at play in the food and beverage space — including increased regulation at the state and federal level and heightened consumer awareness over food labeling and nutrition (and the aggressive litigation that often follows) — and the continued appetite (excuse the pun) for food and beverage opportunities, buyers and sellers would be well-advised to pay careful attention to the following insurance-related matters.
Insurance Coverage Due Diligence
Buy-side due diligence of the target company’s insurance portfolio is critical for any M&A transaction, regardless of industry sector. As part of its due diligence program, the buyer will want to assess gaps or deficiencies in coverage and consider whether the target company has adequate records of its historical liability policies. Depending on the structure of the transaction, occurrence-based liability policies may provide valuable protection to the buyer for any claims that arise following a transaction’s closing. The buyer will also want to assess the target company’s loss history, as this can expose coverage deficiencies and also reveal business practices that may not otherwise be readily discernable.
The failure to uncover potential issues relating to the target company’s insurance regime could expose the buyer to numerous risks. These include leaving the buyer with no coverage or inadequate coverage for liabilities that may arise out of the operation of the target company’s business, whether before or after closing. While the same is true in most M&A transactions, the risks are more acute in food and beverage deals, given the nature of the businesses and operations involved and the scrutiny under which food and beverage companies operate.
Food and beverage companies have long operated under substantial threat of regulatory action and civil liability for food contamination, even if contamination occurs at a single site. But with the increased risk of criminal prosecution of food company executives, buyers would be prudent to review officers and directors coverage in case of related indemnity and other similar claims.[1] Recent U.S. Food and Drug Administration action over the use of partially hydrogenated oils is another source of concern, as adulteration in the target company’s supply chain can cause problems that arise well after closing.[2]
For food and beverage industry targets, the buyer should conduct a thorough analysis and assessment of the following coverages: general liability, products liability, product recall/testing, contingent business interruption, and food contamination/spoilage insurance. These coverages can be particularly important to address potential regulatory liabilities and, also, to cover potential liabilities for foodborne illness. Indeed, recent cases highlight these risks, and buyers would be prudent to address these liabilities through appropriate insurance.[3] Likewise, target companies and buyers alike should be increasingly focused on comprehensive insurance that can address and mitigate risks arising out of interruption to their business and supply chains. These risks are especially acute in light of heightened governmental oversight, predominantly the Consumer Product Safety Improvement Act of 2008 and the Food Safety Modernization Act of 2011. And uncertainty about the scope of regulation of food labeling, particularly claims of “GMO free” products, has changed the risk profile of food and beverage companies.[4]
Insurance due diligence should also assess whether the buyer will be able to acquire the target company’s insurance policies. Buyers should determine whether a change-of-control transaction (for instance, a stock acquisition) will cause an automatic termination of the target company’s insurance policies or give any carrier a termination right. In an asset acquisition, buyers will need to assess the assignability of insurance policies by the target company. While most insurance policies prohibit assignment, carriers may consent to assignments so long as the assignment takes place before a covered loss occurs and does not expand the underlying coverage. Finally, if a transaction is structured as a stand-alone acquisition of a subsidiary or business unit, the buyer will need to ensure that the subsidiary or business unit is adequately covered by insurance, as subsidiaries’ and business units’ insurance is often tied to the insurance programs of other entities (such as parent entities).
Even where the buyer will not acquire the target company’s insurance policies — whether by choice or because such policies prohibit the buyer from doing so — analyzing the target company’s insurance program is still useful. Often, knowing what insurance the target company has historically maintained will inform the buyer’s determination of the types of insurance it should obtain.
Buyers are often well-advised to engage an industry expert to assist in making coverage determination; insurance brokers experienced in transactional matters are often the best choice. These brokers can provide invaluable assistance to the buyer by analyzing the adequacy of the target company’s existing insurance portfolio and assisting the buyer in putting supplemental protection in place to address any deficiencies in coverage.
Transactional Insurance
A hot topic of late is the increasing use of representations and warranties (R&W) insurance in M&A transactions. This insurance provides coverage for buyers for certain breaches of the seller’s deal representations and warranties. While it remains to be seen whether R&W insurance will become the new normal in private company M&A, there’s little doubt that, under the right circumstances, R&W insurance can be an invaluable tool to bridge the gap between buyers and sellers, although all R&W insurance policies come with their own set of benefits and drawbacks, including cost (in the form of premiums, retentions and fees) and scope of exclusions.[5]
For the buyer, R&W insurance can provide a leg up over other bidders in an M&A auction process. The buyer with this benefit may be in a better position to be more aggressive on deal pricing, in the form of lower escrows or holdbacks, higher indemnification baskets, and lower liability caps.
For the seller, R&W insurance can reduce its post-closing exposure for breaches of representations and warranties. This is particularly attractive for private equity funds seeking to make clean exits. Through sell-side R&W insurance policies, sellers can distribute more proceeds to their investors at closing without having to hold back a portion or implement a “clawback” to satisfy post-closing indemnity claims for breaches of representations and warranties. Notably, however, these policies cannot supplant careful due diligence of the target company. These policies are not “a diligence shortcut,” as “[u]nderwriters will carefully review the underlying acquisition agreement and the accompanying diligence.”[6]
In addition to R&W insurance, many carriers offer hybrid insurance products for M&A deals with increased risk exposure, such as litigation, intellectual property infringement and accounting methods liability. Contingent liability insurance, for instance, provides coverage for claims that are likely to occur or that cover matters on disclosure schedules, which would not be covered by R&W insurance.
Tail Coverage
Generally, insurance policies provide coverage on an “occurrence” or “claims-made” basis. Many policies — notably general liability and products liability policies — are offered on either an occurrence or claims-made basis, while other policies, such as product recall and contamination insurance, typically are offered only on a claims-made basis. An occurrence-based insurance policy covers defined losses that “occur” while the policy was in effect, whether the policy is later canceled or not renewed. A claims-made insurance policy, on the other hand, protects the insured against covered losses that occur during the policy period and for which a claim is made while the policy is in effect.
In the context of an M&A transaction, if the buyer will not acquire the target company’s claims-made policies, the buyer should consider whether to purchase a “tail” policy, or an extended reporting period (ERP), to cover preclosing occurrences that arise post-closing. This coverage is particularly important where the target company’s business has a high risk of errors and omissions liability. In the absence of a tail policy or ERP, coverage will only be provided so long as the underlying claims-made policy remains in effect. For the buyer, the obvious risk is that, once a transaction closes, the seller may choose to cancel or not renew its claims-made policies. If that happens, the seller’s financial wherewithal to cover transactional liabilities could be impaired. Tail coverage or ERP is often an economical way to keep coverage intact, and thus is an attractive option. Finally, the parties should consider the availability of cost-effective alternative coverages, such as ensuring that coverage for preclosing occurrences will continue under a claims-made policy.
Conclusion
In the fast-paced environment of food and beverage M&A, it is all too easy for parties and their advisers to treat insurance matters as an afterthought. Yet insurance is more essential than ever in the food and beverage sector, and simply too important to cast aside. Deal lawyers and their clients must be prepared to address these matters as they arise and tailor the transaction structure and their negotiations accordingly.
[1] For an analysis of the increased risks of criminal prosecution, see “ The Increasing Risk Of Criminal Prosecution For Food Cos.,” Law360, Jan. 22, 2016, Alex Brackett, James Neale, R. Trent Taylor and George Terwilliger, McGuireWoods LLP.
[2] See “The Impact of the FDA Banning PHOs in the US,” Food Manufacturing, June 17, 2015, James Neale, Andrew Phillips and Angela Spivey, McGuireWoods LLP.
[3] See “Food Safety Crisis & Risk Management”, complimentary webinar, March 3, 2016, Robert Bittman, Alex Brackett, Mark Hubbard, James Neale, Angela Spivey, R. Trent Taylor, McGuireWoods LLP.
[4] According to a recent analysis, “an FDA rule defining ‘natural’ might provide consumers more certainty about the food they eat, could trump increasingly common state legislation on the subject and may curtail the flood of class-action litigation challenging ‘natural’ claims on products that contain genetically engineered organisms (GMOs) or bioengineered ingredients, or that are otherwise processed in a manner objectionable to certain stakeholders.” “The FDA Gets Pulled Into the ‘Natural’ Labeling Fray: Surprise Move May Change the Food Fight,” Food Manufacturing, Nov. 19, 2015, Benjamin Abel, James Neale, Andrew Phillips and Angela Spivey, Food and Beverage Industry Team, McGuireWoods LLP.
[5] For a more detailed analysis of the use of R&W insurance in mergers and acquisitions transactions, see “ Reps And Warranties Insurance Rises In Health Care Deals,” Law360, April 23, 2014, Bradley S. Austin, Geoffrey C. Cockrell, Joshua D. Davey, Amber McGraw Walsh, McGuireWoods LLP.
This article was originally published as part of a regular feature on Law360 as part of a regular feature which covers private equity and mergers and acquisitions trends in the food and beverage industry.