Calculating Damages In Representations And Warranties Cases

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Mergers and acquisitions (“M&A“) can be a double-edged sword. When done right, M&A can allow acquirers to scale their businesses and create value through synergies. When done poorly, M&A can result in drastic overpayments for assets that are not nearly as valuable as believed and for economies of scale that are very difficult to achieve.

One of the main risks in M&A is information asymmetry: simply put, the vendor knows much more about its business than the acquirer. While the acquirer is able to perform due diligence, time pressures to close the deal mean that this process can sometimes be imperfect; issues are sometimes missed.  This is where Representations and Warranties (R&W) insurance can come into play. This brief article provides a brief overview of R&W insurance, and discusses some of the issues we have encountered as forensic accountants and business valuators in quantifying losses under this type of insurance coverage.

What is R&W Insurance?

R&W insurance provides indemnity for “losses” related to overpayment by the acquirer resulting from breaches of representations and warranties as set out in the purchase agreement for the acquisition.

These types of policies are becoming increasingly popular. One global broker recently reported a 30% increase in deals written in 2018 compared with the prior year. The average policy limit was equal to 15% of the total enterprise value of the deal (e.g. a deal for $100M would have a policy limit of $15M); while deductibles were generally set at 1% of enterprise value. The same publication also reported that premiums have been declining over the past two years, as more insurers enter this market. Another publication by a leading insurer in the space mentions that the frequency of claims has been roughly one claim for every five transactions.

Two types of mistakes

Based on our experience quantifying losses under R&W coverage, there are two main types of misrepresentations: one-time misrepresentations and long-term misrepresentations.

One-time misrepresentations

These types of misrepresentations generally relate to the balance sheet. M&A transactions typically will set a target level of “net working capital”, based on an overall understanding of the subject company. If issues with this calculation are discovered following the closing, the economic loss to the purchaser is generally equal to the amount of the misstatement.

Quantifying these types of issues involves first obtaining a detailed understanding of the components of the purchase price and ensuring that the alleged misrepresentations are not already factored into the price. For example, if the claim is that a large amount of inventory had to be written off following closing, one would need to make sure that the inventory balance included in the closing statements did not already consider a provision for obsolete inventory.

Long-term misrepresentations

Long-term misrepresentations will tend to involve the income statement. For instance, in one case we were recently involved in, the seller had represented to the purchaser that it was not subject to a particular type of property tax. This turned out to be incorrect, and as a result the purchaser was liable to pay this additional, unexpected amount every year for the foreseeable future. In that case, the loss to the purchaser is equal to the present value of the ongoing annual tax liabilities.

How does one value these sorts of long-term misrepresentations? One shorthand approach might be to simply apply the acquisition multiplier to the value of the annual misstatement. For instance, if the deal multiplier was 10 times the seller’s trailing EBITDA, and the value of a misrepresentation (such as the unreported property tax issue) is $1M per year, then one might reasonably conclude that the value of the misstatement is $10M.

This approach can be appropriate in some cases, but sometimes it can lead to incorrect results, when the cash flows associated with the misrepresentation in question have different characteristics (term, riskiness or growth forecast) than the acquired business as a whole. Consider the following example:

  • The business being sold has two divisions, Rapid Robotics and Flat Pancakes. After-tax cash flows last year were $10M ($5M for each division), and the business recently sold for $200M, or 20 times after-tax cash flows.
  • It was discovered that due to regulatory changes in the pancake market (which were known to the seller prior to the deal), Flat Pancakes will need to eliminate a particular product line that accounted for $1M in after-tax cash flows. The purchaser advances a claim for $20M, equal to the annual value of the misrepresentation of $1M times the acquisition multiplier of 20 times.
  • The problem with this approach is the 20x multiplier may actually consist of a multiple of 30 times cash flows for the Rapid Robotics division, and only 10 times cash flows for the Flat Pancakes division. The higher multiplier for Rapid Robotics would represent the value attributed by the purchaser to the anticipated growth in that division.
  • This means that the value of the $1M misrepresentation in the slow-growth Flat Pancakes division is only $10M, not $20M.

In order to perform a proper analysis of these longer-term misrepresentations, it is therefore generally very beneficial to obtain a copy of the valuation model used by the acquirer in the transaction in order to understand how the transaction multiplier was arrived at and to reverse engineer the impact of the particular misrepresentation on business value.

Closing

This article has only scratched the surface of the types of issues that, in our experience, can arise from post-acquisition M&A disputes. As M&A insurance becomes, in the words of one insurer, “the new normal”, we will no doubt have the opportunity to revisit this topic in future articles.

About Dentons

Dentons is the world’s first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. Driven to provide clients a competitive edge, and connected to the communities where its clients want to do business, Dentons knows that understanding local cultures is crucial to successfully completing a deal, resolving a dispute or solving a business challenge. Now the world’s largest law firm, Dentons’ global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 locations serving 50-plus countries. www.dentons.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Specific Questions relating to this article should be addressed directly to the author.

Defense Doctor Criticised For “Advocacy” and Requiring Cross Examination to “Ferret Out” Opinions

Source: Erik Magraken BC Injury and ICBC Claims Blog

Adding to this site’s archived posts of judicial criticism of expert witness advocacy, reasons for judgment were published today by the BC Supreme Court, New Westminster Registry, rejecting a defence expert for shortcomings in their opinion evidence.

In today’s case (Soltan v. Glasgow) the Plaintiff was injured in two collisions that the Defendants accepted fault for.  In the course of litigation the Defendants retained an orthopaedic surgeon who provided opinion evidence minimizing the impact of the Plaintiff’s injuries and prognosis.  In finding it “difficult to ascribe any weight” to these opinions Mr. Justice Saunders provided the following critical comments:

[32]         Having said that, I find it difficult to ascribe any weight to Dr. Boyle’s opinion. His opinions as to the “greater than 50%” likelihoods of certain outcomes, as described above, were stated in a conclusory manner. Rule 11-6 of the Supreme Court Civil Rules, B.C. Reg. 168/2009 requires that an expert state the reasons for their opinion, and indeed the letter of instruction from ICBC to Dr. Boyle specifically asked him to provide his reasons. In contrast to Dr. Hershler, who explicitly stated in his October 2015 report that his opinion was based on his experience with patient outcomes, and the fact that recovery can be prolonged when there have been multiple accidents, Dr. Boyle did not set out what path of reasoning led to the opinions he expresses. His report stated a number of positive and negative prognostic factors, but he did not weigh or analyze them in any fashion.

[33]         If Dr. Boyle’s unstated reasoning behind his opinions was simply that there were no objective signs of pathology, then his failure to acknowledge the subjective nature of pain and the possibility that Ms. Soltan may have found her pain levels intolerable, would mark his report as a work of advocacy. So too would his implication that a prognosis for probable full resolution of soft tissue symptoms may be based solely on objective criteria. The function of an expert witness is to assist the court, not to take sides. To demonstrate fairness and balance, Dr. Boyle’s acknowledgement of the potential for subjective pain being limiting and disabling, even in the absence of objective signs, ought to have been stated frankly in his report and not left to be ferreted out in cross-examination.

[34]         I also note that Dr. Boyle did not state in his report that Ms. Soltan’s decision to take time off work, commencing in February 2017, would not have been a reasonable approach to managing her symptoms and attempting to accelerate the process of recovery.

[35]         For these reasons, I prefer and accept the opinions of Dr. Hershler.

Advocacy in the Guise of Opinion, bc injury law, Mr. Justice Saunders, Soltan v. Glasgow

IBC shares ‘Uncomfortable’ ICBC Facts

VANCOUVER, Sept. 12, 2019 /CNW/ – On September 1, 2019, Insurance Corporation of British Columbia (ICBC) dramatically changed the way it prices auto insurance. While these changes were designed to make drivers better off, the lack of choice and competition in the market means quite the opposite is true.

“More and more drivers are discovering the uncomfortable truth that, under ICBC’s new rate design, buying auto insurance in BC is growing ever more complex and costly,” said Aaron Sutherland, Vice-President, Pacific, Insurance Bureau of Canada(IBC). “The pain BC drivers face with ICBC’s monopoly isn’t going away. Now, more than ever, the market must be opened to competition and choice to improve the affordability of auto insurance.”

Drivers in BC pay more for auto insurance than anyone else in Canada, on average $1,832. Yet they receive the same amount when they make a claim. Today, they also face many fees and other cost increases that drivers in other provinces do not.

“Moving to a risk-based pricing model makes sense, as high-risk drivers should pay for the risk they present on our roadways. However, in the process, ICBC has introduced new fees and costs that no other drivers in the country face, making auto insurance in BC even more expensive than it already was,” added Sutherland.

Additional Resources
Full report on how competition can save drivers up to $325 annually: Benefits of Competition in the Provision of Automobile Insurance in BC 
Poll: Auto Insurance Attitudes in BC 
To learn more, visit: BetterAutoInsuranceBC.ca

About Insurance Bureau of Canada
Insurance Bureau of Canada (IBC) is the national industry association representing Canada’s private home, auto and business insurers. Its member companies make up 90% of the property and casualty (P&C) insurance market in Canada. For more than 50 years, IBC has worked with governments across the country to help make affordable home, auto and business insurance available for all Canadians. IBC supports the vision of consumers and governments trusting, valuing and supporting the private P&C insurance industry. It champions key issues and helps educate consumers on how best to protect their homes, cars, businesses and properties.

P&C insurance touches the lives of nearly every Canadian and plays a critical role in keeping businesses safe and the Canadian economy strong. It employs more than 128,000 Canadians, contributes $9.4 billion in taxes and has a total premium base of $59.6 billion.

For media releases and more information, visit IBC’s Media Centre at www.ibc.ca. Follow IBC on Twitter @IBC_West and like us on Facebook. If you have a question about home, auto or business insurance, contact IBC’s Consumer Information Centre at 1-844-2ask-IBC (1-844-227-5422).

SOURCE Insurance Bureau of Canada

Related Links

www.ibc.ca

‘If you have something serious, you call into one of those 1-800 numbers and get yourself into the queue’

Read more
Hurricane Dorian: Advice and information from Insurance Bureau of Canada

Hurricane Dorian: Advice and information from Insurance Bureau of Canada

HALIFAX, Sept. 9, 2019 /CNW/ – In the aftermath of Hurricane Dorian, Insurance Bureau of Canada (IBC) is reaching out with tips and advice for those who have been affected.

“We know is that there has been significant damage across the region, and a lot of families have had their lives disrupted.  When you are able to call, your insurer is ready to hear the details of your claim,” said Amanda Dean, Vice-President, Atlantic, IBC.

What insurance covers
Most car, home and business insurance policies cover damage caused by a hurricane or tropical storm. Your insurance representative is at the ready to clarify the details of your policies.

The claims process
If you have been affected by Hurricane Dorian, when it is safe to do so, take the following steps:

  • Assess and document the damage. Taking photos can be helpful.
  • Call your insurance representative and/or company.
  • List all damaged or destroyed items.
  • If possible, assemble proofs of purchase, photos, receipts and warranties. Keep damaged items unless they pose a health hazard.
  • If you have to move out of your home because of insured damage, check with your insurance representative about whether your policy includes additional living expenses coverage, which may cover your costs if you have to move into a hotel/motel.

Next steps

  • Once you have reported a loss, you will be assigned a claims adjuster. It may take some time given the number of people affected by Dorian, but you will be contacted.
  • The claims adjuster will investigate the circumstances of the loss, examine the documents you provide and explain the process. Take notes during these conversations and don’t be afraid to ask questions.

Resources
Anyone with questions should contact their insurance representative or, for general information, contact IBC’s Consumer Information Centre at 1-844-2ask-IBC.

Additional resources
IBC.ca – severe weather
IBC.ca – Preparing for severe weather

About Insurance Bureau of Canada

Insurance Bureau of Canada (IBC) is the national industry association representing Canada’s private home, auto and business insurers. Its member companies make up 90% of the property and casualty (P&C) insurance market in Canada. For more than 50 years, IBC has worked with governments across the country to help make affordable home, auto and business insurance available for all Canadians. IBC supports the vision of consumers and governments trusting, valuing and supporting the private P&C insurance industry. It champions key issues and helps educate consumers on how best to protect their homes, cars, businesses and properties.

P&C insurance touches the lives of nearly every Canadian and plays a critical role in keeping businesses safe and the Canadian economy strong. It employs more than 128,000 Canadians, pays $9.4 billion in taxes and has a total premium base of $59.6 billion.

For media releases and more information, visit IBC’s Media Centre at www.ibc.ca. Follow IBC on Twitter @InsuranceBureau and @IBC_Atlantic or like us on Facebook. If you have a question about home, auto or business insurance, contact IBC’s Consumer Information Centre at 1-844-2ask-IBC.

If you require more information, IBC spokespeople are available to discuss the details in this media release.

SOURCE Insurance Bureau of Canada

www.ibc.ca

Cheech And Chong Get Into A Car Accident

Cheech And Chong Get Into A Car Accident

Article by Christopher Macaulay

“Do my insurance benefits cover my medical marijuana costs?”

It’s a question that claimants are increasingly asking of their first-party healthcare insurers, and one that is not always easily answered.

On one hand, the use of cannabis as a legitimate treatment option has grown exponentially in recent years. On the other, the associated medical literature is in somewhat of a nascent stage, and it is not always clear whether marijuana will aid an injured party with their recovery (at least in any clinically verifiable sense).

In the recent LAT case of F.F. and Aviva Insurance Canada,1 the Tribunal was faced with the question of whether a treatment plan for medical marijuana was reasonable or necessary to treat a claimant’s anxiety and depression.

Facts

The insurer denied the treatment plan on the basis of a psychiatric expert report. The psychiatrist did not recommend cannabis as a form of treatment for the claimant’s psychological impairments. He highlighted the fact that there was limited clinical research to support the use of marijuana in treatment of anxiety symptoms.

Despite referencing the psychiatrist’s view of the clinical research, the Tribunal did not delve into what this research actually says. It is unclear whether any medical literature was put before the hearing Adjudicator.

The claimant relied predominantly on the opinion of his family doctor for his evidence. The family doctor’s records confirmed that the claimant had reported little relief from traditional psychiatric medication and psychotherapy. However, he had shown a marked improvement in both his psychological and physical well-being with the use of medical marijuana. He had also noticed an improvement in his sleep quality while using the drug.

In light of these results, the claimant’s family doctor was supportive of medical marijuana as a viable treatment option. This opinion was corroborated by a letter from a treating nurse who had also noticed the claimant’s improvements when he began to use marijuana.

Decision

The Tribunal preferred the claimant’s evidence and ordered the treatment plan payable in its entirety. The Decision highlighted the fact that the insurer’s expert psychiatric report failed to consider relevant details about the claimant’s treatment course; for instance, that the claimant had already tried traditional psychiatric medication and psychotherapy with little to no improvement before submitting his treatment plan for medical marijuana.

Interestingly, the Decision also ordered the insurer to fund a related treatment plan for a medical marijuana assessment. The Tribunal held that such an assessment would be reasonable “to determine what would be an appropriate marijuana product” for the claimant.

Questions Raised

The Decision was undoubtedly a resounding win for the involved claimant. However, the Tribunal’s underlying reasoning raises the question of whether a claimant who turns straight to medical marijuana, without first attempting more traditional pharmacological interventions, would have the same level of success.

On a separate note, if the Decision’s findings with respect to the marijuana assessment are left to stand, this seems to open the door for cannabis clinics to submit similar assessment costs for nearly every claimant with a medical marijuana prescription. Will a cottage industry of quasi-medical “personalized cannabis evaluations” spring up? Time will tell.

Lessons Learned

One clear takeaway from the Decision is that a blanket reliance on (a lack of) medical literature will not suffice as a primary reason to deny a medical marijuana treatment plan. The Decision implicitly follows the standard set by prior SABS case law that there is no requirement for a claimant to prove to a medical certainty that a treatment will be therapeutic.2

In a broader sense, the Decision presents another example of the ever-increasing role that the cannabis industry is beginning to play within personal injury litigation. In years past, both FSCO and the LAT grappled with the idea of marijuana as a treatment modality by contrasting the illegality of recreational cannabis with its purely clinical uses.3 This distinction has since been blurred through federal legalization of the drug for recreational use. Both first and third party insurers can expect to see an increase in claims factoring medical marijuana into treatment and future care costs as a result.

  1. 18-002994/AABS.
  2. Pacquette and Certas Direct Insurance Company, FSCO A05-000934.
  3. See: Biro v. Unica Insurance Inc., FSCO A109-001753; M.J. and Pembridge Insurance Company, 16-000583/AABS.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Source: Mondaq

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