The non-negotiables of non-payment insurance policies

In this episode, Ellie Ruiz and Kelly Knight discuss the ins and outs of non-payment insurance policies. They address the non-negotiables and other key issues that policyholders should be aware of when purchasing non-payment insurance.----more----

Transcript: 

Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's Insurance Recovery lawyers from around the globe. In this podcast series, we explore trends, issues and topics of interest affecting commercial policyholders. If you have any questions about the topics discussed in this podcast, please contact our speakers at insuredsuccess@reedsmith.com We'll be happy to assist.

Ellie: Hello and welcome to the Insured Success podcast. My name's Ellie Ruiz and I'm a senior associate in the insurance recovery group at Reed Smith. Today for this episode, I'll be speaking with Kelly Knight from the Reed Smith Structured Finance team and discussing the ins the outs and the non-negotiables of non-payment insurance policies. We're aiming to refresh the key issues for clients you're aware of when they're purchasing non-payment cover. And then Kelly has very kindly rounded up some common queries she sees from clients including this type of cover to mitigate credit risk in financing transactions with a particular focus on receivables financing.

Kelly: Thanks, Ellie, you and I have worked together on a receivables financing which raised a number of questions about the nature and scope of non payment insurance. And I've had clients raise similar questions on other deals which include credit insurance as a former credit support. We both know how important the insurance cover can be to our clients as policy holders when putting together receivables, financing transactions. So I'm looking forward to going over the fundamentals with you and discussing what we should be looking out for. So I think the best place to start might be a quick overview of what non payment insurance is exactly and when clients might want to consider taking it out.

Ellie: Perfect. Ok, so starting from the beginning, non-payment insurance, also known as trade credit insurance, it's a form of credit protection that protects a client from a payment default by the other party in a deal i.e. when there's a failure to make a payment on a scheduled due date. So there's a really nice degree of simplicity to non-payment insurance in that all that you require is a simple failure to make a scheduled payment. And that reason for failure to make the payment can be either an inability to pay, for example, due to change of financial circumstances or it can be a deliberate refusal to pay due to a dispute between the parties. These kind of policies do have the ability to be tailored to the specifics of each transaction, given the complexities, the underlying deals that you would be working on or that we're talking about. So it's particularly advantageous to have that level of flexibility between insurer and insured?

Kelly: Ok. Understood. And when considering how to take out non-payment insurance for receivables financing, what are the advantages or disadvantages to structuring cover as either two separate policies held by each of the seller and the purchaser or alternatively taking a single policy with the seller and the purchaser both named as co insured.

Ellie: So they're both interesting options. The advantage of being co-insured on one single policy be that either party. So the purchaser or seller could make a claim and be indemnified under just one policy, albeit you have two separate contracts. The idea is that one policy can still reflect different interests of two parties. But then there's no need for two policies to be purchased covering the same risk, the interests and rights of the purchaser and seller remains separate, which is critical, but subject to policy wording, an insured would be able to recover under the policy even if the other co insured has breached any of its terms because it's only breaching its own contract with the insurer. On the other hand, the disadvantages to being co-insured. A. there's a single policy limit which can be eroded by a claim from either party which might not be so agreeable to both parties on the deal. And B. there's less clear delineation between which insured is covered in respect of which receivables at any one time. And as you and I both know, it's always the gray area where you end up having the disputes; either between the parties or with insurers. In addition, sometimes insurers might reject the idea of co-insuring a seller and a buyer in a deal of this nature on the basis that insurers then can't pursue a subrogate recovery against one insured for an insured loss suffered by the other insured. So if it is a loss that is being caused by either seller or purchaser, then the insurer can't make a subrogate recovery because logically, there's no purpose in bringing a subrogate claim when the insurer would be liable to indemnify the claim once it had to be met.

Kelly: Ok. Got that. Um Now, to complicate matters further in many of our receivables financing deals, a purchaser will be receiving funding from one or more investors who typically will want any claim under a credit insurance policy to be paid to them directly. In your experience. Can insurance coverage be structured to achieve this. For example, can an investor or a security agent acting on behalf of investors also be a co-insured?

Ellie: It certainly it's possible. This kind of arrangement is - it's a policy by policy decision. But if we're looking at it from a very high level, there is the option to either add as a co-insured or alternatively, you can name an investor or a security agent here potentially as a loss payee. So as we've just been discussing, there are some clear disadvantages to being co insured And in addition to those that I just mentioned, when you're talking about investors, it's also worth noting that by becoming an insured, those investors would then have disclosure and other obligations to the insurers which can be hard to satisfied given their proximity to the deal and how much information they would have. Alternatively, a loss payee is just identified as having first rights over any payment out that's made by insurers. So that would address your initial query regarding any claim being paid out directly to investors. It also voids the need for a separate contract between insurers and investors. However, a loss pay lacks the authority of an insured under a policy. So they can't, for example, make a claim under the policy and absent any express language, clear evidence of a separate agreement, they wouldn't be able to enforce directly any lost payment rights against the insurer. So in that situation, realistically, the relationship between the purchaser and the investors in terms of how they treat that insurance policy would probably still need to be governed by separate documentation between them which the insurer then isn't a party to.

Kelly: Ok. Sort of. So lots to think about there. So when clients are going to insurers to put together a non-payment policy for complex financing deals like the ones we we deal with in our structure, finance team, will they be expected to have a complete picture of the deal structure in place or or final documentation to share with the insurer?

Ellie: Not initially, I I mean, I've seen when we've worked together how many iterations some of these documents go through. And I think at the stage where we're just trying to talk to insurers and put a policy in place at the beginning, a client would just be having to complete a proposal form of some sort or other. So you're applying for the non-payment insurance and you're just aiming to give sufficient information to offer the policy. In that context, the transaction would need to be described in some level of detail in the proposal form. And then ultimately, it's usually closer to when the policy contract is about to sign. The insurers are likely to want to see final form or very near to final form documentation. It's probably a timing issue there and what gets signed first and who requires what? But in particular, the receivable sale and purchase agreement is something that insurers are likely to want to see and understand. There's also on top of that and a much more general nature, there is a duty of fair presentation in accordance with our 2015 Insurance Act, which an insured is obliged to comply with. And that includes providing information, ensuring material representations are correct and also that no material information is withheld or misstated. So on a higher level, that kind of covers not being able to hide anything or change anything at the last minute that the insurers weren't aware of.

Kelly: Oh, well, thanks Ellie. That's, that's been really helpful just thinking about sort of specifics. What would be the key date that clients should be aware of in a non-payment policy?

Ellie: Hm, um Go to the obvious one first, policy period sounds almost too obvious. There's a start date and an end date, but in particular, the policy end date should ideally be very closely tied to the underlying transactional documentation And those related definitions just want to be very clear. There's no gap between when the deal itself has come to an end and when the insurance itself stops providing cover. Secondly, there's often a lot of definitions surrounding due date, date of loss. Due date is usually that scheduled date for payment of the debt, which goes back to that original description of what exactly non-payment insurance is. And then there's likely to be a very specifically defined date of loss, which is closely linked to the due date. And this is all about just ensuring the insurer and insured are clear about when a loss has actually been suffered. And in addition to that, I think it's always worth looking at the waiting period, which is often found in policies like these, it’s generally a period following that date of loss before the insured loss is payable. This is one that can be negotiated between insurer and insured and potentially it can vary depending on the circumstances of the loss. For example, if the loss is as a result of insolvency or deliberate refusal to pay those might be different specific time periods.

Kelly: Ok. Thanks Ellie. A term that we often see bandied about is, is insured percentage. Uh So, you know, as, as you can imagine, our, our clients are quite keen to understand what would leave uninsured, what would be an uninsured percentage.

Ellie: Yeah, I can see they might have some concerns there. Um What it means is just this policy is gonna pay out a percentage of the outstanding debt, but it won't be paying out 100%. Usually we find that insured percentage is anywhere between 75 and 95%. Depends on what's been purchased. The reason for this is an insurer will want to ensure that the client retains significant skin in the game and that just ensures their commitment to the deal and they're not using the insurance like a like a parachute. “Oh, well, never mind. No payment. We've got insurance.”

Kelly: Ok. That, that's interesting. I know some of our clients when they take out a non payment insurance policy, they, they view it as almost like a silver bullet that's going to cover all non payment risk in their deals. Is this correct or are sort of non payments uh such as, I don't know, non payment by a customer as a result of a dispute that might not be covered under insurance policy?

Ellie: Well, in theory, it is probably possible to have a policy which covers all nonpayments, but I have never seen one. In reality, it's unlikely. The place you're looking in a policy for the answer to that kind of question is the exclusion section. And that tells you what losses or nonpayments aren't going to be covered. The common ones that we would almost expect to see are non payments that are caused by the policyholder themselves or a deliberate breach or default under deal, documentation, failure to comply with material laws or regulations. The policyholder becoming insolvent or the policyholder engaging in fraudulent or criminal behavior that's relevant to the deal. So take your, you know, traffic issues to one side. In the case of non-payment by a customer as a result of a dispute. The key point tonight is there can be payment out but if that dispute is ultimately resolved and it's resolved in favor of the policy holder after the insurer has paid the claim out, there's an overriding rule against double recovery. So the policyholder can't take the money from the insurer and from succeeding in the dispute. So the policy will generally provide that that money has then be paid directly back to the insurer.

Kelly: right, ok. So in in respect of the uninsured percentage, so our clients sort of risk exposure would a client be allowed to look to mitigate that credit risk through other forms of credit support, you know, for example, like parent guarantee or something similar?

Ellie: It, it would vary policy to policy, but it's definitely, you're absolutely right. It's something that our clients should be aware of and it's something to consider really carefully. It's not at all uncommon as you say that a policyholder client like this might be wanting to benefit from a contractual guarantee or an indemnity. Some insurers will require that any other insurance or indemnities or guarantees which might cover the same losses should be called upon first. So they'll just put themselves in a ranking and say your parent company, if they've still got money, they pay out first and we all pay when you don't have any other options. Alternatively, it might be a requirement that just any recovery is made under the other insurances or guarantees indemnities are applied first before the non-payment policy steps in. In particular, in relation to that uninsured percentage. You remember, as I mentioned before, insurers preference for the client to keep some skin in the game. The policy might require that this particular percentage remains completely uninsured and that no other insurance cover or guarantee can be taken out in respect of that amount that may or may not be the case. We're talking about a company very closely related to the policyholder, but they're not going to want it to free up that sense of risk and being a little bit cautious mitigating any potential risk.

Kelly: Ok. Well, that's, that's definitely something that, you know, we ought to be taking into consideration when when structuring the transaction. Um just, just kind of going back to our discussion earlier about whether insurers would be expecting to see complete documentation of the proposal form stage. What about amendments that are made to deal documents after the credit insurance policy has been taken out, will insurers want to see that or want some sort of input?

Ellie: It's a very valid point because of course, just given the complexity of those deals that we've been looking at, it's obviously it's not uncommon for some changes to be needed in respect of the underlying documentation in these transactions over the course of deals that might be in place for a year or two. However, for the insurers, it's all about being able to just understand and manage the risk. So clients should realistically expect to see what we call a material amendments clause in that policy requires that insurers are told about and potentially have to give prior written consent to any material amendments for the insurance cover to remain in place. The nuance then I think comes in what exactly is a material amendment and that's where we sort of focus our efforts. You pay close attention to that. For example, some scenarios, those amendments might be able to be made on the deal side, they can be made without the insured's agreement, let alone insurer consent. So if your insurers put in a requirement that they need to consent to this first, it's completely implausible and doesn't fit with how the deal documentation operates. So just making sure that what's in the deal documentation and what's in the insurance policy align is really important.

Kelly: Ok. That makes sense. So looking ahead if for example, there was a situation where a policyholder client thought that they might be entitled to cover under their non-payment policy. What should they be keeping in mind? Like for example, what are the key timing points that they ought to be aware of? And, and obligations would there be on, on the client once they, once they suspected that a non payment event has occurred?

Ellie: Right, this is, yeah, we get the good stuff once they, once we're actually starting to look at making a claim. So firstly, you want to check the policy wording again and identify first and foremost the notification provisions and the exact detail they contain this is because the obligation to notify often comes way before the obligation to make a claim. So that's at the stage where you, you mentioned the word “suspected” and it's at that stage, generally at which insurers have to have that flagged up to them. As a general rule, it's then advisable to liaise with brokers or insurers directly if that's how the policy has been set up and to do that promptly as well, just to make sure that everybody knows they've been told. And when they've been told. More generally, the policyholder client wants to be alive to any regular reporting obligations. Suspicions aside, the policy is likely to provide for obligations to ensure insurers are up to date about the deal's progress, scheduled payment dates that have been met thus far. And a part of this also involves maintaining good records of those communications and payments provides a clear trail for insurers to follow if we get to a claim scenario. The insured is often under an obligation to take reasonable steps to avert or minimize loss and wants to avoid any unreasonable steps that might increase the loss. On the other side of the coin sometimes costs like this. What we call mitigation costs will be covered under the policy. You just want to check the wording in each case. And then finally, a policy can specifically require an insured to cooperate with an insurer in the pursuit of what a subrogate claim. So this comes further down the line if a claim was paid out and the insurer takes on that role and the obligations on the policy holder can include protecting any rights which may or may not have been segregated and potentially specific requirements further down the line to assist in an actual recovery action depending on how far that goes in terms of providing access to individuals, documentation, records and so on.

Kelly: Oh, interesting. So you, you, you mentioned sort of subrogation which sort of brings me on to my next question for you. So if our client has, has made a claim and has received a payout under the insurance policy. If subsequently, the client manages to recover some of that claim from its from its customer, for example, or some other party, how should the client be treating those recoveries?

Ellie: It's worth going back here to that notion we were discussing earlier, this idea of an insured percentage and an uninsured percentage. I would expect overall a policy to explicitly deal with how recoveries are going to be applied. But generally, it's likely to be the case that first and foremost costs and expenses will be covered. And then after that recoveries would most likely be applied pro rata between the insured and the uninsured percentage. So, insurer and insured are recovering pro rata at about the same rate. Following payment of a claim, this is when an insurer has a right of subrogation that entices them to step into the shoes of the policy holder and they can exercise any of those policyholder rights or remedies against third parties. Again, this should generally be expressly set out in the policy and it can only take effect once the policyholder has been fully indemnified. As we flagged earlier one of the reasons that insurers might actually reject the idea of co-insuring a seller and a purchaser in a deal like this is because of that inability to pursue subrogated recovery against the seller if you're dealing with the purchase or the other way round for an insured loss, that's been suffered. Again it's purely logically what is the point in having a segregated claim where you're also the insurer on the other side having to meet that claim. So I think that's probably about all we've got time for today. It's a bit of a whistle stop tour through the key elements of non-payment trade credit insurance which can be complicated. Um But hopefully that gives a little bit more context to our finance clients or anyone looking to incorporate one of these policies into receivables financing. Kelly, is there anything else you wanted to add?

Kelly: Nothing for me- just to say, thank you very much.

Ellie: Brilliant. Thank you so much everyone for listening.

Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcast, Google Podcast, PodBean and reedsmith.com. To learn more about Reed Smith's insurance recovery group please contact insuredsuccess@reedsmith.com.

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