Risks rising in corporate dealmaking

Liberty GTS, which specialises in transactional risk insurance products such as representations and warranties insurance, has made this warning to alert risk managers after analysing claims over the past two years. The answer, says its President Rowan Bamford, is: “Check, check and check again.”

In claims resulting from M&A deals, Liberty GTS finds that accounting and financial issues remain significant, especially in the Americas. Many of these claims involve stock and inventory issues and can be large, some in excess of £37 million ($50 million). 

According to the company’s most recent claims report: “We see a high number of claims relating to revenue recognition issues, including overestimation of expected revenue, reallocation of costs, or even management fabricating revenue for goods yet to be supplied. These are other ways that financials can be manipulated, including delays in the recognition of impairments to assets, the understatement of allowances or overstatement of accounts receivables.”

Rowan Bamford says real fraud is rare, but the stresses and uncertainty of Covid-19 put pressure on some managements to take an over-optimistic view to remain in business. Mistakes are also occurring as a result of the high staff turnover. Replacement staff may not know how every client is invoiced, and it affects the accounting.

The risks of such mis-statements and manipulation may be exacerbated if remote working and reduced levels of staff have reduced oversights and checks during the due diligence process. Buyers may also not have been able to get the good access to premises and facilities.

Cyber and IT claims rising

Unsurprisingly, there have been ever more claims involving cyber-attacks, with victims including financial institutions, healthcare companies, education establishments and infrastructure. M&A insurers increasingly see this as a risk that businesses ought to manage by purchasing a bespoke cyber policy with suitable cover and adequate limits. 

Claims involving software licensing shortfalls also continue to grow. Liberty GTS believes this is an unstoppable trend, given the rise in audits carried out by software vendors. 

Major IT projects that are part way through roll-out at the time of the sale are an increasingly common source of claims. They typically relate to missed milestones, higher than expected costs or the failure of the project. 

Other causes

Claims involving contract-related issues have been rising, especially in the Americas. The most common issues involve a failure to disclose changes to high-revenue contracts.  In a number of these cases, had the buyer spoken to the key customer concerned, the issue would most likely have been discovered before deal signing – a point to note for future deal diligence.

These types of claims can be surprisingly expensive and can result in additional tax liabilities, plus an increased wage bill.  Wage claims are a growing risk area and carry an added ‘social inflation’ exposure, especially in the US.

Third-party claims, relating to a dispute that was already ongoing at time of acquisition, make up a more significant portion of claims notifications than many appreciate.  The number has been steadily increasing.

This summary highlights growing sources of dispute after a deal is transacted. The answer to many of them is check, check and check again. “Due diligence must mean just that”, says Rowan Bamford.