Simon Radcliffe, head of claims at Liberty GTS, is an experienced lawyer specializing in investigating and assessing policy claims, particularly high-value M&A insurance claims. Before joining GTS, Simon worked as a senior associate at Norton Rose Fulbright and undertook secondments at two leading Lloyd's syndicates.
The growth of the M&A market globally has been significantly subdued since the heady post-COVID-19 boom that we experienced at the end of 2020 and throughout 2021. However, this market slowdown has not prevented the uptick in M&A insurance claims caused by the post-COVID-19 M&A surge. As businesses explore all avenues to grow in this challenging economic environment, they are often exposed to an increased litigation threat, which has led to a significant number of third-party claims, according to Liberty GTS’ upcoming annual claims briefing.
The report is an in-depth assessment of M&A insurance claims based on data drawn from 525 notifications received since 2019 in 14 jurisdictions across the Americas, Asia-Pacific (APAC), and Europe, the Middle East & Africa (EMEA).
The report found that, this year, third-party claims continue to make up a significant proportion of its notifications. The Americas region continues to see a majority—nearly 57%—of its non-tax-related representations & warranties (R&W) notifications involving third-party claims. In contrast, our EMEA and APAC regions have reported lower figures in the past 18 months, at 32.3% and 42.9%, respectively.
Compliance with laws, intellectual property (IP), and wage-and-hour disputes are responsible for many third-party claims
There are three underlying causes of loss that make up the bulk of our third-party claims: compliance with laws, wage-and-hour class action lawsuits, and intellectual property disputes.
Compliance-with-laws claims have accounted for 19% of our notifications involving third-party claims. They are particularly prevalent in the Americas, with government investigations into past business practices being the most predominant type of loss notified. These claims most frequently involve the healthcare industry and investigations into billing regulations. We also often see claims involving data privacy compliance issues and, more recently, allegations around anticompetitive conduct (for instance, price fixing). These types of claims can result in significant fines, especially if not resolved promptly.
Wage-and-hour lawsuits have accounted for 13% of our notifications involving third-party claims. They are frequently venued in California, where the laws and courts are believed to be largely employee friendly. It is typical for plaintiffs’ lawyers to work on contingency-fee arrangements, meaning that nuisance-value settlement offers are generally rejected. There is also a legal system abuse risk associated with these claims, raising the possibility for outsized jury awards. We often find that the target’s business-as-usual insurance program seldom provides coverage, as it generally excludes wage-and-hour claims (save for the occasional minimal sublimit for defense costs).
IP disputes have accounted for 7% of our notifications involving third-party claims. We find that these claims are usually pursued very aggressively by highly motivated plaintiffs determined to protect their IP rights. They typically entail substantial litigation costs, given the high counsel fees coupled with the fact that these matters are not easily resolved via dispositive motions. Indeed, we have handled several IP claims where the target company is likely to incur more than $5 million in defense costs and achieving a sensible settlement proves to be difficult given the entrenched position of the plaintiff. Another factor fueling the increase in IP claims, particularly in the Americas, is the rise of “patent trolls,” who exploit patent litigation for settlements based on (often) frivolous claims. We find patent trolling to be less prevalent in EMEA and APAC, particularly in jurisdictions that have a loser-pays-costs regime.
Defense costs are presenting M&A insurers with significant exposure
Most significantly, the paid and reserved amounts related to third-party claims—and defense costs in particular—have surged over the past few years. They currently account for about 17% of total dollars that we have paid or reserved to date. The majority of this is attributable to the Americas region, where we have paid or reserved more than $35 million in relation to defense costs alone.
It is becoming increasingly more common to receive litigation budgets exceeding $5 million, particularly in IP and complex contractual disputes. In the Americas, we have seen multiple claims involving eight-figure defense spend. Indeed, one of our largest payments to date involved a complex contractual dispute, with nearly $30 million paid out—$20 million of which was for defense costs. Another ongoing litigation, involving a hotly contested IP infringement dispute, is expected to result in more than $10 million in defense costs through trial.
There are a number of factors driving increased defense costs exposure
The litigation style in the Americas, characterized by extensive motion practice and intensive discovery, inherently leads to costly disputes—more so than seen in EMEA and APAC. We also presume that the recent surge in defense costs is also being driven by macroeconomic factors, particularly inflationary pressures, which have prompted law firms to increase their hourly rates.
While the law firms used to defend third-party claims are often preapproved in R&W policies—with their rates deemed reasonable—it is not always the case that the preapproved firm will be the most suitable or cost-effective choice. As a result, as evidenced above, it is becoming more common for defense costs to materially erode or exhaust retentions—a trend that is likely to be exacerbated by the pressure that retentions have recently come under, coupled with the fact that, in the Americas, third-party claims frequently arise after the retention dropdown date when the retention is generally halved one year after closing.
This is likely to prompt questions over whether M&A insurers need more input over key decisions relating to a covered third-party claim as well as the associated defense costs spend than is currently the case in some jurisdictions.
Early notice of third-party claims is crucial
It is critically important that M&A insurers receive prompt notice of a third-party claim and are given the ability to closely associate in its defense. Our experience underscores that, by maintaining active dialogue regarding a claim’s status and any key developments, an insurer can expeditiously reach a coverage determination—frequently aligning the interests of both carrier and insured in contesting the third-party claim—and assess the reasonableness of any key strategic decisions or settlement proposals. While rare, we have encountered instances where third-party claims were notified after the dispute had already been settled (on one occasion for an eight-figure sum). We find that delayed notification complicates the claims process, especially if key decisions have already been made.
Looking ahead
We anticipate that, as exposure to third-party claims becomes more frequent (and more severe), M&A insurers will apply more scrutiny at the underwriting stage around litigation risk in general and start to take increasingly robust positions in respect of any potential exposures that are identified during due diligence, even if they are classified as low-risk items.
We also expect that, because R&W policies often sit in excess of any other valid, applicable, and collectible insurance coverage, more detailed questions will be asked by M&A insurers about the adequacy of the risk and insurance due diligence that has been performed by the buyer. The focus here will be on checking that the buyer has a comprehensive understanding of the target’s existing insurance programs, their scope and limitations, and their level of comfort adequately addressing key risks in order to avoid a situation where the R&W policy becomes the first port of call for, or starts to be treated as top-up cover for, business-as-usual risks.
