How Representations and Warranties Insurance Can Protect Buyers and Sellers in M&A Deals

Losses experienced by a buyer of a company can be costly and, in some cases, result in a claim against the seller under the representations and warranties made in the acquisition. Buyers may be left without the ability to recover losses, or sellers may be forced to hand back a portion of the purchase price.

Representations and warranties insurance (“RWI”) can help combat this. RWI helps protect both buyers and sellers from financial loss in the event structured protection is negotiated to levels below market conventions. RWI, which provides benefits to both buyers and sellers, has become a popular tool to help bridge negotiation gaps in private equity transactions.

According to a memo by George Wang of the Haynes and Boone law firm, “RWI is an insurance product in which either the buyer or seller in an M&A transaction secures protection against breaches of the representations and warranties[i].” These breaches are sometimes incurred by the sellers and discovered post-closing. Writes Wang, “RWI may reduce or even eliminate the need for escrows or purchase price holdbacks and indemnity retention limits, thereby facilitating negotiation and completion of M&A transactions more expediently. While the typical policy will not insure a buyer against breaches of representations or warranties known to the insured, the standard is typically the ‘actual’ knowledge or awareness of the insured’s deal team performing the due diligence review.”

As experienced deal professionals, attorneys often recommend RWI to their clients. Josh Hollingsworth of Barnes & Thornburg in Indianapolis states, “Every single middle market M&A seller, buyer, and advisor should be considering representation and warranty insurance for their deal. While it might not fit every deal, the insurance products are much more attractive today than just a few years ago.“

While either a buyer or seller can purchase RWI, there are important differences in the policies. Typical terms for policies include:

• Available limits of up to $50 million for any one transaction (larger programs can be arranged on a case-by-case basis)
• Premiums from 2-5 percent of the limit of liability purchased
• Deductibles between 1-3 percent of the transaction value

In addition, buy-side policies may enable the buyer to recover losses directly from the insurer without the need to pursue remedies against the seller. Sell-side policies will not protect against seller fraud, but may provide third-party coverage (e.g., defense costs and losses asserted by the buyer).

In today’s market, PE buyers are increasingly faced with sellers offering no (or a very low) seller indemnity. This phenomenon is driven by demand for good acquisitions exceeding supply in many markets. RWI is a good option for the PE buyers that desire protection but want to facilitate a transaction and make their purchase offer competitive. According to an article by Weil, “a buyer’s willingness to forego [market-based seller] indemnity in reliance upon RWI may distinguish such buyer from other bidders.”[ii]. Josh Hollingsworth adds, “The decision whether to obtain insurance will affect the timing and structure of the deal, so it needs to be thoughtfully made on the front end of the deal.”

RWI can also benefit PE buyers by providing a longer protection period than could typically be obtained from sellers (e.g., three years for general reps and six years for fundamental and tax reps). In addition, Weil’s article notes, RWI provides coverage limits that are not necessarily tied to a percentage of purchase price, thus allowing buyer to obtain more coverage than could typically be obtained from sellers[iii].

RWI is a tool with many benefits for M&A transactions, and should be considered by legal and banking advisors as part of the structure.

[i] George Wang, www.law360.com/articles/650228/reps-and-warranties-keeping-m-a-liabilities-in-check, 4/29/2015.

[ii]Joseph Verdesca and Gabriel Gershowitz, R&W Insurance, https://privateequity.weil.com/insights/rw-insurance-part-pros-cons-buyers/, 5/27/2015.

[iii] Ibid.