John A. Gibbons and James S. Carter
Recent events and the decline of the global economy have brought a raft of notices of late payments or no payments for creditors, lenders, landlords, and trade counterparties. In many instances there may be no notice at all, but rather just silence and a nonpayment. With the downturn and record number of layoffs and closures also comes the specter of further prolonged defaults and bankruptcies.
Is there insurance to protect against a nonpayment? Yes. Beyond Business Interruption / Business Income and other insurance policies that cover losses from recent events and business suspension losses, there is specific insurance designed to protect against the risk of nonpayment of a debt: Credit Insurance / Trade Credit Insurance.
What Is Credit Insurance?
Credit insurance protects those that purchase the insurance against the risk of nonpayment of an insured debt. Purchasers of credit insurance can fall within a wide array of businesses—lenders, exporters, commodity traders, product suppliers. Credit Insurance is typically used to protect a company’s own account receivables (“AR”) against the risk of nonpayment.
Credit Insurance can also provide protection for companies involved in some form of asset-based lending (“ABL”) that rely on accounts receivable as the main asset or collateral to secure the debt. For example, companies that sell products, goods, or commodities on credit, may take a collateral interest in the assets of the borrower, customer, or counterparty. Those assets will frequently be the accounts receivable of the borrower, customer, or counterparty. Credit insurance can then be purchased as an additional asset, beyond the accounts receivable or other pledged assets, to provide an additional hedge and protection against nonpayment/default.
Credit insurance pays a percentage of an unpaid debt and may include costs of efforts to recover a debt, for example, if the debtor enters into bankruptcy. The insurance can be used to protect domestic U.S. transactions as well as international trade and transactions across the globe. While there are a number of large established companies that offer “off the shelf” credit insurance products, the credit insurance market is a specialized market that can frequently provide bespoke solutions tailored to a particular portfolio of transactions or a single transaction. The participants in the credit insurance market have expressed an appetite for innovative structures that may not be as typical in other insurance transactions.
Credit insurance policies involve very specific and particularized underwriting, and, most importantly for policyholders, can involve highly technical reporting in the event of a late payment or nonpayment, i.e., default. The reporting may include continual monitoring of the borrowing base and adherence to maximum borrowing / minimum collateral criteria that may be included in the insurance policy terms and conditions. The technical nature of reporting and other provisions requires vigilance by policyholders. Experience shows that insurers under pressure frequently seek to avoid their obligations by arguing for forfeitures of insurance on purely technical grounds.
Credit Insurers under Pressure
Just as they were during the financial crises in the mid-2000s, with the current expected downturn credit insurers are likely to face a spike in claims. Moody’s has downgraded many trade credit insurers. Public reporting also notes that trade credit insurers are already planning to scale back coverage, particularly in areas such as Italy and Spain. But that may not be the only strategy credit insurers pursue. Policyholders depending on quick claims payments may face an increasingly challenging claims environment marked by adversarial delays and denials. For a number of companies, April 1, 2020, came with numerous requests for payment extensions or forbearances.
Types of Issues Credit Insurers May Raise
A common defense of credit insurers is that the policyholder failed to disclose material information or terms when the policyholder applied for coverage. Credit transactions can be incredibly complex, making them in the eyes of insurers fertile ground for contentions that the policyholder failed to disclose material terms.
Credit insurance policies often contain complex collateral requirements. Insurers may challenge whether a transaction met the requirements. Such matters may involve issues relating to the structure and priority of competing collateral interests.
Some credit insurance policies permit insureds to underwrite transactions based on criteria set forth in the credit insurance policies. Credit insurers may question whether the insured followed the prescribed procedures.
Late or Insufficient Notice
Like other types of insurance policies and claims, insurers can resort to a denial of coverage by claiming some issue with the policyholder’s notice under the credit insurance. This notice argument can be particularly complex because of the highly technical terms and reporting provisions that credit insurers frequently write into the policies.
Although it is frequent that borrowers or counterparties will ask for some form of accommodation in difficult financial times, and these accommodation measures actually may be in the interest of both the creditor and borrower, insurers may seize upon these actions (after the fact) to seek some benefit for themselves by arguing they have been adversely impacted by the accommodation. These arguments frequently lack merit but can nonetheless be costly and time consuming to address. As such, policyholders must be careful and aware of their full policy rights and obligations, including the arguments that insurers raise to delay or deny claims.
What Should Policyholders Do?
Credit insurance is a vital asset for companies whose customers are failing to pay accounts receivables and debts. As the recent, unprecedented shock to the global economy continues and trade credit insurers’ exposure expands, policyholders may encounter an increasingly challenging claims environment. Policyholders seeking to recover from their credit insurers must be careful to present their claims on the best possible footing and scrutinize attempts by insurers to unjustifiably deny or limit coverage.