Transaction Liability Private Enterprise (TLPE) insurance, a relatively new transactional liability insurance product, has taken off in a big way with savvy Buyers in the lower middle market.
It’s no wonder.
TLPE fills a gap for deals that traditional Representations & Warranty (R&W) insurance won’t cover. TLPE policies are designed to cover transactions from $1M to $30M to the full purchase price – for a maximum of $20M.
TLPE coverage is easy to get, with minimal underwriting. The cost is a fraction of traditional R&W policies. On top of that, insurers pay promptly if the Buyer brings a legitimate claim for damages against the Seller.
However, there is a problem. Fortunately, it has an easy solution, as you’ll see in a moment.
First, a little background.
Let’s say a Seller makes an untrue statement about their company. This so-called innocent, or accidental, misrepresentation is not technically fraud because it was not done maliciously. Plus, with today’s regulatory environment, combined with unsophisticated Sellers, these types of issues can happen.
Whatever, the circumstances these misrepresentations can be a serious issue because they can result in costly losses to Buyers. With TLPE coverage in place, the Buyers call collect from an insurer that will pay the Claim rather than having to pursue the Seller or exhaust the escrow which the Seller is counting on.
The real issue comes when a Seller does engage in fraud and negligent misrepresentation. Here’s how it is defined in policy documents for a specialized type of coverage I’m about to reveal:
The Seller engaged in the following that resulted in damage to the Buyer:
- Represented false material facts as true;
- Actively concealed and prevented you from discovering the truth; or
- Remained silent in the face of a duty to speak, (a false representation) with the seller making such false representation with:
- Knowledge or belief that the false representation was false, with reckless indifference to the truth; and
- The intention to induce you to take action or refrain from acting based on the false representation.
This is how Seller negligent misrepresentation is defined:
- The Seller had a pecuniary duty to provide accurate information;
- The Seller supplied false information;
- The Seller failed to exercise reasonable care in obtaining or communicating the information; and
- The Buyer suffered a pecuniary loss caused by justifiable reliance upon the false information.
Buyers today do have a real concern that this fraud could happen. And it’s not covered by standard TLPE coverage. Fortunately, Buyers can still protect themselves against purposely negligent and fraudulent Sellers.
How Buyer Protect Insurance Works
This insurance is a new type of Buy-side coverage that indemnifies Buyers from their financial loss resulting from a breach of Seller reps where the Seller had knowledge certain reps were inaccurate or false.
Buyer Protect fills the gap in TLPE policies by covering those breaches specifically carved out by the Seller Fraud exclusion. This complimentary policy will reimburse the Buyer for loss resulting from a fraudulent breach – beyond the deductible.
A claim must be filed under the Seller’s TLPE policy as well as under the Buyer Protect policy. In the event the TLPE policy excludes coverage as a result of Seller Fraud, the Buyer Protect immediately steps in to reimburse the Buyer.
Simply put, Buyers can be cynical and sometimes feel that certain Sellers are out and out lying, or… they just don’t know what they don’t know. In either case, they want to hedge their risk.
Enter Buyer Protect coverage, which used to be called Fraud Nondisclosure or Seller Nondisclosure. This policy is available only where TLPE coverage is to be secured. There’s no application; however, a Buyer does have to request – it’s not automatic. At a cost of $5,000 per $1M in Limits (subject to tax), Buyer Protect should be a “must-have” for all deals where TLPE is involved.
If you have any questions about Buyer Protect insurance or TLPE coverage in general, I’m happy to help. I have been involved in several deals using TLPE as it has rolled out over the last few years.
Please contact me, Patrick Stroth, for more information on TLPE and other M&A insurance options at pstroth@rubiconins.com.