In last week’s blog we looked at some insurance lingo and gave you our top five jargon busters. This week we will look at some of the themes which commonly crop up on transactions when negotiating insurance provisions in finance documents.
The sticking points
6. Cancellation of policies
Lenders need to know if the insurer cancels any of the borrower’s insurance policies, particularly if it is for the non-payment of insurance premiums. In order to remain protected, lenders often require that not only are they notified of any cancellation but that the policy is not effectively cancelled until the expiry of a notice period. A 14-30 day notice period is fairly common and it gives the lender some time to rectify the breach by bringing the premiums up-to-date.
Insurers are often loathe to agree to such a requirement arguing that it prejudices their position if they delay the cancellation of the policy for any period of time.
A prudent lender will often turn to the insurance broker for comfort that the non-cancellation wording is contained in the insurance policy at the time of issuing his broker’s letter.
7. Effectiveness of a broker’s letter
A broker’s letter is a letter from the borrower’s insurance broker which confirms that the borrower has put in place insurance which complies with the terms of the facility agreement and/or the relevant security documentation.
Usually, the letter outlines the policies in place, confirms that premiums are paid and are up-to-date, that a notice period applies before the policy is cancelled for non-payment of premiums and that the insurance is usual for a company carrying on the same business as the borrower.
However, negotiating the specific wording of the undertakings to be given by the broker often takes some time and a broker may not wish to have any potential liability to the lender. The requirement for a broker’s letter is a common condition precedent that often leads to a delay in completion of a transaction. The borrower should be asked to make contact with their broker early on in the transaction to avoid any delay.
8. Duty of disclosure
Anyone applying for or renewing a policy of insurance is obliged to disclose “every material circumstance” to the insurer. A circumstance is material if it would “influence the judgment of a prudent underwriter in fixing the premium or determining whether he will take the risk”.
There are different types of non-disclosure: fraudulent, negligent or innocent.
To what extent are lenders, as co-insured, subject to the duty of disclosure?
This is an area of some uncertainty. The duty of disclosure applies to any insured party, but the borrower, not the lender, will be the party who presents the risk to the insurers and will also have much greater knowledge of the risk than the lender. It seems that the lender’s duty of disclosure would, in practical terms, be quite limited. Of course, if the lender becomes aware of a material circumstance which might not have been properly disclosed to the insurers, the lender should ensure that this is drawn to the attention of the insurers. A good example would be if the sum insured under the policy was known to be too low.
The lender should ensure that it has the protection of a good “non-vitiation” clause in the policy, so that if the borrower’s cover is vitiated for non-disclosure by the borrower, this will not vitiate the lender’s cover.
9. Amending policies
There may be times when a current insurance policy needs to be amended. The lender will want to know if any amendments to any policies are made, but the question is, how can the lender control this process?
The lender has two principal options available to it. Firstly, it can request that the insurer notifies them of any amendments, whether they are material ones or not. The lender may even request that no amendments can be made without their prior written consent. If this is an important requirement for the lender, they should ensure that the broker’s letter confirms that this condition has been complied with. Secondly, the lender can include this obligation within its finance documents thereby restricting the borrower from applying for such amendments to be made in the first place. Such a restriction would commonly be found in the representations and covenants contained in the facility agreement and/or security documents.
10. Application of proceeds
A lender and a borrower will usually have conflicting interests when it comes to applying any insurance proceeds which are paid out by an insurer. The LMA Real Estate Finance facility agreement contains insurance provisions which confirm that the lender is happy for any insurance proceeds to be used towards replacing and reinstating any property. On the other hand, the LMA Leveraged Finance facility agreement contains insurance provisions which confirm that insurance proceeds should be used to repay the facility.
However, not all transactions involve the use of LMA documentation and in order to achieve the best outcome, lenders should consider their insurance requirements on a transaction by transaction basis. Lenders need to take into account the nature of the borrower’s business and in particular, the nature of their assets. If a borrower has a property portfolio, then replacing and reinstating the property will be relevant but if the borrower’s assets consist of intellectual property then repaying the facility will be the lender’s main priority.
Furthermore, lenders should be aware that borrowers usually have existing policies in place which they are committed to until they expire. These existing policies may contain provisions contrary to the lender’s requirements, so some early due diligence may pay dividends later down the line, especially if a claim is made.
If an existing policy does not satisfy the lender’s requirements from the outset, the lender should consider whether they can make their insurance requirements a condition subsequent to be satisfied either by the borrower taking out a new policy post-completion or upon renewal of the existing policy.
Thinking about your insurance requirements at the start of a transaction and carrying out some due diligence so that an informed commercial decision can be made as to what insurance provisions need to be included in the documentation will make the negotiation process much easier.