The sale of financial advice portfolios is on the rise and both buyers and sellers are finding new ways to allocate risk, according to Katie Johnston, a senior associate with The Fold Legal.

In the aftermath of the Hayne royal commission, and as financial advisers move towards the deadlines for the implementation of new FASEA requirements, it’s become a buyers’ market, Brisbane-based Johnston reckons.

“Buyers are keen and empowered to limit their exposure and risk to changes to remuneration and poor advice,” Johnston says.

There are a couple of ways motivated buyers are negotiating ways to limit their exposure and risk in transitions, including imposing more stringent warranties and indemnities in their portfolio transfer agreements, she says. Another way buyers are looking to limit their risk is including indemnity clauses which require one party to reimburse another when an agreed event happens, Johnston explains.

Not to be outdone, sellers have ways to counter warranty extensions requested by buyers to limit their exposure and risk, she adds.

Deeper warranties

A warranty is a promise by one party that a particular statement is true and may be relied upon by the other party, Johnston explains.

For example, a seller may warrant that certain compliance requirements have been met – such as opt-in and Fee Disclosure Statements – or warrant the levels of recurring revenue to support the purchase price/value of the sale, Johnston outlines.

“Following the Royal Commission, buyers are more vigilant than ever about the quality of the portfolios they acquire. They are conducting a more extensive due diligence process and asking for better warranties than they have for similar transactions in the past. Buyers also want more certainty around the payment of any PI claims, especially with so many advisers leaving dealer groups who are shutting down their [financial planning] operations entirely,” she says.

According to Johnston, buyers now expect warranties to cover things like:

  • Conduct in servicing clients: This may include the type of services provided, what advice was given, the products issued, compliance issues and even the ‘client to adviser’ ratio.
  • Remuneration: They often want confirmation that fees were not charged where no services were provided, no grandfathered remuneration is included and there are no claw-backs for overcharging fees.
  • Records: Warranties that electronic records are complete and in a satisfactory state to service the clients and deal with client complaints/claims.

To mitigate their risks, buyers are also asking sellers to give personal (owner/director) guarantees for these types of warranties, Johnston continues.

“The rationale behind these requests is to push the risk exposure back onto the seller as much as possible for poor advisory and compliance practices, allowing the buyer to reduce the purchase price for any adverse impact on recurring revenue and retention of the acquired client base. This isn’t entirely unreasonable given the seller is the one who ‘knows’ the clients, the business and its risks,” she says.

Indemnities also gaining favour

Indemnities are a contractual obligation by one party to reimburse the other when an agreed event happens, Johnston explains.

“In the current risk-averse landscape, buyers are seeking to impose catchall general indemnities for any liability arising from the seller’s activities. A better compromise is for the indemnity to cover any breaches of the law, legal negligence, or claims involving clients. Arguably, some of these indemnities are excessive and go beyond what is really needed to protect the buyer, so sellers should resist these and only agree to specific indemnities,” she says.

Specific indemnities are items identified or disclosed in the due diligence process that can’t be resolved because the issue is ongoing where the potential loss is not quantifiable at that time. If the issue can be finalised before completion or dealt with by adjusting the purchase price then it should be done through a reduction to purchase price, rather than relying on indemnities, Johnston says.

In every sale transaction, counter-parties obviously have competing interests, she says.

The key is understanding these interests and appropriately addressing them in the sale agreement, she continues.

“As a buyer, you want to have certainty about your rights to claim against the seller and the seller’s financial resources to meet indemnity and warranty liability. It is essential that the buyer has confidence in the PI insurance arrangement for the seller’s exposure in the period after the sale. Without this, the indemnities are worthless because there will be no safety net for these risk exposures. Equally, as a seller you want to know what your liabilities and obligations to the buyer are and when they will end,” she says.

Sellers limit their exposure too

Sellers can counter warranty extensions requested by buyers to limit their exposure and risk, according to Johnston.

Johnston’s recommendations for sellers include:

  • Cap the amount the buyer can seek for breach of warranty: Determining the amount of the cap is almost always the subject of much negotiation.  A seller shouldn’t accept a higher exposure, and a buyer shouldn’t accept less protection, than the purchase price paid.
  • Cap the time period to make a warranty claim: This gives the seller certainty around their exposure. How long this period should be is usually dictated by any period of deferred payments of purchase price. If it is in instalments over two years, for example, then a two year time period is probably a good compromise, but the exposure for indemnity claims (i.e. six years) may be longer, so this needs to be considered carefully.
  • Set a minimum loss threshold: This can be drafted so that the buyer must suffer an individual loss or an aggregate amount of $X before they can make a warranty claim. What $X is will be contingent on the purchase price and subject to negotiation between the parties. I suggest 3-5 per cent of the purchase price is fair and reasonable in most transactions. Noting that sometimes the parties will set it as the amount of the excess/deductible under the seller’s PI insurance.
  • Set the process: Sellers may want to impose a formal process for how buyers can make a warranty claim. This should be in the agreement and include what notice and information the buyer must give to the seller before they can make a claim and during the process. This is particularly important if the warranties are extensive, the warranty period is long, or the monetary warranty cap is high.
Smith is the editor of Professional Planner’s print and digital platforms. He is an experienced financial journalist, editor and multimedia producer who has held senior editorial positions both in mainstream press and trade media.
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