A Representations and Warranties policy provides coverage for losses incurred as a result of breaches or inaccuracies of the representations and warranties made in business transactions. A seller typically makes numerous representations to the buyer and warrants to the buyer critical facts about the business. These attestations are an inducement to the buyer. While parties both hope that the representations are accurate, disagreements often arise. Such disputes routinely occur in connection with financial condition, accounts receivable or intellectual property. Disagreements can also arise over the scope of representations and warranties made, as well as the duration and amount of a seller’s indemnification obligations.
Often, when a transaction is nearly complete, last-minute issues can create an impasse. It is at this critical juncture that R&W insurance can be utilized to remove obstacles and facilitate closure. The preemptive purchase of R&W insurance can remove fears regarding certain representations that might lead to litigation after the deal closes. An R&W policy can also eliminate the need for a buyer to rely on the seller to make continuing indemnification payments—meaning a buyer wouldn’t need to chase down sellers who might be foreign, insolvent or long gone. In this regard, R&W policies provide both sides of the deal with peace of mind that each party will receive what they believe they bargained for.
HOW are R&W Policies Structured?
Each agreement is unique, and an R&W policy is tailored to meet the specific needs of each deal. Depending on the client’s needs (whether the buyer or seller), R&W policies can be structured to achieve various things. These goals might include: (1) increasing the amount of indemnity available, (2) providing a “backstop” to the indemnity already available, (3) extending the expiration of the indemnity, (4) eliminating the need for collateral for contingent liabilities, (5) providing “ground up” coverage to replace an indemnity, or (6) increasing the scope or breadth of an agreed indemnity.
WHEN should parties consider the purchase of an R&W policy?
Most often, R&W policies are purchased in a mergers-and-acquisitions context. However, R&W policies are also secured in connection with restructurings, insolvencies, liquidations, financings or loans, or in connection with the licensing of intellectual property. In these situations, an R&W policy adds value as it can eliminate or reduce perceived or identified exposures and can address disagreements on the allocation of legal or financial risk for certain perceived or already identified exposures. It can also give one buyer a competitive edge over another.
For example, consider a transaction where the buyer requires that a seller retain liability equal to 30% of deal consideration in respect of breaches of representations and warranties, while the seller is only willing to assume liability for up to 10% of deal consideration. An R&W policy could provide coverage for the buyer for loss resulting from breaches exceeding 10% of deal consideration up to a limit of 30% of deal consideration.
Or consider a situation where the seller’s weak financial position causes the buyer to require that security be posted for seller liability for breach of any representations and warranties. An R&W policy could be designed to cover the buyer for loss resulting from breaches only if the seller is unable to meet the liability it has agreed to assume under the sale agreement.
WHO Buys an R&W Policy?
Buy-side policies make up the majority of R&W policies. A buy-side policy enables the buyer, should a breach occur, to recover losses directly from the insurer without having to make a claim against the seller, often without having to locate and pursue the seller. Such a policy provides the buyer with assurance that the value of the acquired business will not be reduced by unexpected liability. Further, buyers can utilize R&W policies to improve their bargaining position by using the coverage to enhance their bid by reducing the indemnity ceiling and required escrow.
A sell-side policy provides indemnification by the insurer for defense costs and loss resulting from claims made by the buyer for inaccuracies in the transaction that are the subject of seller representations and warranties. Simply put, a sell-side policy also enables the seller to walk away from a closed deal confident that the proceeds it receives in the transaction will not be diminished by subsequent legal claims and claw-back. A sell-side policy provides a structure so that the seller can make a clean break once the sale has been executed by reducing or eliminating the need for an escrow account. This is of great value to the seller as the seller can distribute more of the proceeds from the transaction more quickly, thereby expediting shareholder return (and the purchase of the yacht or sports car that the seller has always wanted).
If I have a client who wants to consider R&W coverage, what information would they need to provide? Generally, underwriters can prepare a non-binding indication with a minimal amount of key information. This information would include (1) the draft purchase agreement, (2) the draft disclosure schedules, and 3) the most recent audited or reviewed financials of the target.
Socius has conferred with Ambridge Partners LLC, a leading managing general underwriter of Representations & Warranties Insurance (R&W), to present this article.
