5-minute read
After a disappointing 2022 and perhaps more disappointing start to 2023, mergers and acquisitions activity is expected to pick up sometime soon. At least that’s what many on Wall Street are hoping.
When it does, whenever that might be, there’s a coverage buyers and sellers will want to consider:
Representations and Warranties Insurance.
In a nutshell, Representations and Warranties coverage protects buyers against financial losses, including costs arising from defending claims, when a breach of a sale happens as a result of either innocent or fraudulent misrepresentations by sellers.
R&W coverage is a non-renewable, single-premium product in which the insurer effectively steps into the shoes of the party making the contractual promises. Your due diligence team, in other words, will be relieved you bought it, should things turn south.
Let's dig into the nuances of this insurance and how it can take some of the anxiety out of deal-making.
What, Exactly, is Representations and Warranties Insurance?
Simply stated, Representations and Warranties Insurance protects against breaches of representations and warranties in a purchase agreement. Representations are factual assertions that a seller makes about their business in a transaction, and warranties are assurances that certain conditions will be met. If these representations or warranties prove inaccurate, it can lead to significant financial liabilities, hence the need for RWI.
For example, say a seller inaccurately represented that its company was in compliance with all applicable regulations. Now suppose that, after the sale, the buyer discovers regulatory violations that lead to fines. The buyer could then make a claim under a R&W insurance policy to recover those costs.
The retentions (or deductibles) in R&W policies typically are set at a minimum of 1% of the deal, an amount that can be borne by either the buyer or the seller or a combination of the two.
Policy periods generally line up with the period of the representations and warranties set forth in the acquisition agreement, although buyer-side coverage can be extended beyond those provisions, giving the buyer more time to uncover any problems.
As you might expect, most R&W policies will include a range of coverage exclusions or limitations. For example, the buyer will not be able to recover for liabilities it knew about when the policy was bound.
In the event of a claim, RWI ensures that the buyer can recover their loss without resorting to litigation or having to prove the seller’s fault. This process is typically quicker and less expensive than a legal proceeding.
Pros and Cons of RWI
Like any strategic decision, purchasing RWI has its advantages and disadvantages.
Pros
Risk Transfer: RWI effectively shifts the risk of financial loss from the buyer or seller to the insurance company, providing peace of mind.
Deal Accelerator: By reducing negotiation time on indemnity provisions, RWI can help expedite the closing of the deal.
Competitive Advantage: In a competitive bidding scenario, a buyer willing to purchase RWI might be more attractive to the seller as it can limit the seller’s post-closing liability.
Cons
Cost: RWI policies can be a bit pricey, often ranging between 2.5% to 3.5% of the coverage limit.
Exclusions: RWI policies typically exclude known risks disclosed during due diligence. Therefore, it may not provide coverage for all possible risks in a transaction.
Claims Process: While often simpler than litigation, the claims process can still be time-consuming and challenging to navigate.
Underwriting Process: Obtaining RWI can be a complex process, requiring a comprehensive review of the deal by the insurer. This can add to the timeline of the deal.
All that aside, R&W Insurance is a potent tool in the M&A world. If you’re thinking about merging, buying, or selling your company, you’ll want to consider R&W coverage. Just one last caution for buyers and sellers alike: because of its complexity, it’s essential to start shopping for R&W insurance as early in the process as possible.
The Mahoney Group, based in Mesa, Ariz., is one of the largest independent insurance and employee benefits brokerages in the U.S. An employee-owned organization, we’ve been providing our clients with the confidence to face whatever lies ahead for more than 100 years. For more information, contact us online or call 877-440-3304.
This article is not intended to be exhaustive, nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel or an insurance professional for appropriate advice.