Private Equity and the Impact of the COVID-19 Pandemic: Part 3 of 3

Viviane Falzon is the Head of Complex Management Liability Claims at Ironshore /Liberty Mutual Insurance Co. Viviane has been with Liberty since October 2016 in her current role. She has 30 years experience in the insurance industry and is licensed attorney with diversified claims and underwriting experience in domestic and international Financial Lines and Specialty insurance products, including Directors and Officers, Investment Managers and Financial Institutions, Professional Errors and Omissions, Employment Practices Liability, Pension Trust Fiduciary Liability, Crime and Fidelity, Cyber Crime and Liability, Representations and Warranties, Surety, and Construction Risk policies.

Scott A. Schechter is a partner at Kaufman Borgeest & Ryan LLP and has been with the firm since 2001. Scotts practice concentrates on representing international and domestic insurers in all aspects of claims handling and coverage litigation, particularly in the areas of Directors and Officers Liability, Financial Institutions Liability (with an emphasis on banking, private equity, hedge funds, venture capital, and investment advisers), and Professional Liability. Scott also defends individuals and companies in professional liability and commercial litigation.

Joshua A. DiLena is a partner at Kaufman Borgeest & Ryan LLP and has been with the firm since 2010. Joshuas practice focuses on Management and Professional Liability involving financial institutions, particularly private equity firms; and also includes the areas of public and private Directors and Officers Liability, Errors and Omissions, and Fiduciary Liability. Joshua represents insurers in all aspects of the claims handling process, as well as coverage litigation.

Matthew E. Mawby Is a partner at Kaufman Borgeest & Ryan LLP and has been with the firm since 2015. Matts practice focuses on complex coverage litigation and arbitration, particularly in the areas of Financial Institutions Liability, Directors and Officers Liability, Professional Liability, and Employment Practices Liability. Matt also counsels international and domestic insurers in all aspects of claims handling and resolution of coverage disputes. Matt also defends individuals and companies in commercial litigation and arbitration.

Andrew S. Paliotta is an associate attorney at Kaufman Borgeest & Ryan LLP and has been with the firm since 2018. Andrews practice concentrates on representing international and domestic insurers in insurance coverage matters and coverage litigations/arbitrations involving Directors and Officers Liability, Employment Practices Liability, Errors and Omissions, and Professional Liability claims. Andrew also represents commercial entities in arbitration and litigation in both state and federal court in professional liability actions and various commercial and construction claims.

This post is Part 3 of this article. Part 1 is available here, and Part 2 is available here.

VIII. Impact on SPAC Transactions

A special purpose acquisition company (SPAC) also referred to as a blank check company is formed to raise funds through an initial public offering (IPO) to be used to acquire an operating company or companies at a later date.[1] The SPACs offering documents are not required to identify any specific target company; and the funds raised through the IPO could be utilized for any business combination in the future (subject to certain time restraints and possibly a focus on a specific industry sector), thus the moniker blank check.

Naturally, a public equity offering via an IPO does not constitute a private equity transaction. Historically, private equity fund managers may have engaged in transactions with unaffiliated SPACs in order to divest an underlying portfolio company. In recent years, however, a number of private equity fund managers have branched out to sponsor their own SPACs.[2] For example, Apollo Global Management (a leading private equity fund manager) recently announced that it was seeking to raise $400 million in a SPAC IPO.[3]

In 2020, SPACs (broadly, not limited to private equity sponsored SPACs) raised over $83 billion in IPOs, more than six times the total from 2019 ($13.6 billion).[4] So far in 2021, SPAC IPOs have already surpassed the record figure set in 2020, raising more than $95 billion.[5] One of the protections offered by a SPAC is that funds raised through the IPO (or the vast majority thereof) are required to be held in trust until deployment on the ultimate acquisition. If the acquisition does not occur within a set time-frame (typically two years from the IPO), the funds are to be returned to the investors (plus accrued interest); and the investors also have an opportunity to seek redemption of their shares at the IPO price at the time the ultimate transaction is announced. As such, SPACs can be viewed as a favorable investment opportunity with downside protection in uncertain economic times.[6]

As with secondaries discussed above, the investor demand for SPAC opportunities may exceed the underlying supply of acquisition targets, with estimates of $40 billion in IPO proceeds available for acquisition targets.[7] As noted above, SPACs are required to complete a business combination within a set timeframe; or return the IPO proceeds to the investors. The SPAC sponsor (or founder) does not typically receive compensation until the closing of the business combination (at which point its founders shares would equate to a 20% ownership in the combined entity). This may create an incentive to push through deals on tighter time frames particularly if the market turmoil created by the pandemic continues well into 2021 and could lead to allegations of lack of due diligence caused by conflicting interests.

VIII. How has COVID-19 affected Liberty Mutual in Underwriting Products offered in the Private Equity Space?

Management Liability Market

For the past five years, the Private Equity Liability space has been identified as an area of focus and growth for Ironshore Insurance, (specialty underwriter for Liberty Mutual).We are currently building a portfolio of policies and insureds across a diverse spectrum of fund sizes and investment strategies.

Ironshore currently has dedicated teams underwriting the Private Equity and General Professional Liability (GPL) Lines along with Portfolio Company D&O (Commercial D&O).We consider ourselves as differentiators in the marketplace because of our diverse underwriting experience and knowledge, our constant collaboration between our Claims and Underwriting teams, and Liberty Mutuals Financial Strength and relationships with Private Equity Firms.

Certainly COVID-19 has presented challenges in underwriting this business. In addition to taking into consideration the financial strength and financial health of Portfolio Companies, we are looking into how the Private Equity Sponsors have assisted their Management teams throughout the crisis. We are focusing on building a book of business based on limits management and attachment points with Insureds and Sponsors having Assets Under Management or Committed Capital of between $250 million and $10 billion. While we will entertain submissions from a broad array of investment mandates, our underwriting appetite is concentrated on the prospective management team, experience and prior performance.

Ironshores Financial Institution team currently underwrites its standard Private Equity /General Partnership Liability Policy for Fund Sponsors which provides the following coverages: Management Liability (D&O), Investment Advisors E&O (PL), Employment Practices Liability, Pension Trust Liability, and Crime coverage. The Commercial D&O team underwrites coverages for the Portfolio Companies on Ironshores corresponding Public or Private D&O insurance forms, Employment Practices Liability, Fiduciary Liability and Crime Policies. The optional Crime coverage is underwritten by our Fidelity team of underwriters. These products have been widely recognized as a competitive base form in the marketplace.

Liberty Mutual can also offer core coverages, such as workers compensation, general liability, auto liability, excess liability, umbrella, property, and inland marine, for Private Equity firms and their portfolio companies.

Representations & Warranty Market

In January 2019, Liberty Global Transactions Solutions (GTS) was formed in the United States to underwrite Representations & Warranties Policies. The underwriting team has grown substantially due to this ever-developing market and demand for this product in the Private Equity space. Currently, Liberty GTS has a team of 17 underwriters situated in New York, Houston, San Francisco, Boston and Toronto, Canada. Most of our underwriters have experience as corporate attorneys so they are well versed in the needs of our corporate clients which consist mostly of Private Equity firms and strategic buyers.

Liberty GTS does business with the full brokerage communities. Underwriting these Private Equity deals has been challenging through COVID-19; however, we have seen a strong past several months of both submission and deals in active underwriting. For instance, at the end of May 2020, we saw over 50% fewer submissions than we did at the same time in 2019 largely due to changes in the M&A landscape caused by COVID-19. By the end of June 2020, we saw 22% fewer new submissions than in the prior year, and by the end of July 2020 we were down 9%. However, by the end of August 2020, we started to see a shift as submissions were up by 23%, followed by 49% in September 2020. This trend continued as we saw an increase in submissions by nearly 70% by the end of October 2020 and 93% by the end of November 2020 with no signs of slowing down. Regarding bound deals, in 2020 we have almost doubled our numbers compared to 2019 and have seen a very busy and almost unprecedented M&A season as we approached the end of 2020. We attribute this increase in business and success due to Libertys commitment to this line of business, the expansion of its underwriting team, its commercial mindset in getting deals done and working closely with its Claims organization in following through with its promises to its clients.

Conclusion

If anything is certain, it is that the COVID-19 pandemic has created a world of uncertainty for every aspect of daily life and the impacts of COVID-19 will continue long after the majority of the world is able to become vaccinated. For PE firms, the impacts will likely include increased due diligence into the types of businesses they invest in and the portfolio companies they acquire, as well as the potential for increased scrutiny of the employment practices of their portfolio companies and how they view business opportunities moving forward. Given the impacts from COVID-19 creating the potential for heightened scrutiny and exposure for PE firms not just in the remainder of 2021, but potentially years from now, the pandemic is also creating unknown levels of uncertainty for underwriters in the professional liability market. A recent special report issued by AM Best in conjunction with the Professional Liability Underwriting Society[8] found that two-thirds of respondents to a special survey found that the pandemic has created the highest level of severity on D&O renewal pricing – where reports indicate rate hikes of more than 20% and include more restrictive terms and conditions. Respondents also reported a tightening of terms and conditions on Employment Practices Liability coverage, which is not unexpected given the potential employment exposures discussed in this report. For other professional lines, the impact may not be felt for years such as medical professional liability lines, where malpractice litigation related to COVID-19 may be delayed due to court backlog or legal battles over immunity statutes enacted in various states.

The first part of this article is available here, and the second part is available here.

[1] https://corporatefinanceinstitute.com/resources/knowledge/strategy/special-purpose-acquisition-company-spac/

[2] https://pitchbook.com/news/articles/private-equity-spacs-2020s

[3] https://www.reuters.com/article/us-spartan-acquisition-ipo/apollo-backed-spac-aims-to-raise-400-million-in-u-s-ipo-idUSKBN26U2LS

[4] https://hbr.org/2021/02/the-spac-bubble-is-about-to-burst

[5] https://www.spacanalytics.com/

[6] https://www.penews.com/articles/the-spac-market-is-deflating-heres-why-20200817#

[7] https://www.spacanalytics.com/

[8] https://amp.insurancejournal.com/news/national/2020/11/13/590495.htm

Neither Ironshore nor any other Liberty Mutual company (the Insurer) are engaged in the practice of law. The foregoing information is for informational purposes only. It is not a substitute for legal advice from a licensed attorney, nor does it create an attorney-client relationship. The Insurer disclaims all liability arising out of this resource.

This document provides a general description of this program and/or service. Not all insurance coverages or products are available in all states or regions and policy terms may vary based on individual state or region requirements. See your policy, service contract, or program documentation for actual terms and conditions. Some policies may be placed with a surplus lines insurer. Surplus lines insurers generally do not participate in state guaranty funds and coverage may only be obtained through duly licensed surplus lines brokers.