Issue 1 Volume 1

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Key Approaches To Capping Existing Liabilities

The ability to “cap” or transfer existing liabilities on the balance sheet to a third party (i.e., an insurance carrier) is a financial risk strategy that is once again gaining popularity and is increasingly being used by both public and private companies to manage balance sheet risk. Simply put, this “insurance for burning buildings” serves to create certainty in an otherwise uncertain environment. While these “capping” structures can cover many types of litigation, the most popular typically include securities class action lawsuits, environmental, employment and general liabilities.

These financial solutions can be especially powerful in an M&A transaction when a buyer conducts the preliminary due diligence on a potential target and research uncovers a pending lawsuit or open ended liability. In several recent deals procured by Worldwide, the use of these solutions has eliminated the litigation hurdle and allowed the buyer and seller to complete the deal.

Additionally, during the past six months, we’ve seen a significant increase in the utilization of these capping mechanisms by private companies who are preparing themselves for sale. Capping an open ended liability at a pre-determined amount often will result in a company being able to attract more bidders and ultimately a higher sales price.

Subsequent to a complimentary review by Worldwide to determine if a solution is available, insurance carriers will often require an up front fee in order to conduct due diligence necessary to adequately quantify the risk and provide a balance sheet solution. This initial fee is then credited towards the ultimate premium paid. The average time it takes to secure a quotation is typically 10-14 business days. Premiums will be predicated upon a number of different factors including the amount of limits required, the type of litigation/liability and at what stage the litigation is in.

Given the heightened requirements of oversight and due diligence applicable to directors and officers of both private and public companies, it is not uncommon for senior executives, board members and outside advisors to at least explore these solutions from a fiduciary perspective.