The Role of Representations and Warranties Insurance Policies in M&A Deals

Representation and warranty insurance, also known as R&W insurance, refers to insurance coverage specifically for the breach of representations and warranties contained in a purchase agreement or merger agreement. In other words, R&W insurance policies can cover unforeseen costs resulting from breaches of representations by the seller or buyer that may arise post-closing.

In recent years, there has been a steady increase in the use of R&W insurance. As a result, the number of R&W insurance brokers and insurance providers has correspondingly increased. This has in turn led to increased standardization of R&W insurance terms and streamlined procedures for obtaining a policy. R&W insurance can play an important role in facilitating and closing M&A transactions. R&W insurance can be used in addition to or as a replacement for post-closing indemnification obligations.

The retention amount, also known as the deductible, is expressed as a percentage of the overall transaction size. The retention amount is typically 1-2% of the deal value. The premium amount is not related to the transaction size. Rather, the premium is expressed as a percentage of the coverage limit. Premiums usually range from 2.5-4% of the coverage limit.

Both seller and buyers in an M&A deal may find R&W insurance beneficial. From the seller’s perspective, R&W insurance can reduce the possibility of post-closing disputes. The parties might agree to eliminate post-closing contingent liabilities and indemnification obligations for the seller if there is a R&W insurance policy. This can be especially appealing to private equity sellers, who want to reduce the likelihood of post-closing disputes between the private equity fund and its limited partners.

R&W insurance can also be beneficial to the acquiror. In a competitive auction situation, a buyer can purchase R&W insurance to make their bid more attractive and enhance their chances of winning the bid. The buyer can also obtain a R&W insurance policy with longer survival periods of representations and warranties and higher cover limits. This typically consists of three years of coverage for general representations and six years of coverage for tax representations and fundamental representations.

From the acquiror’s perspective, R&W insurance also provides a source for reimbursement in the event of seller breaches. This is especially useful if the seller may be insolvent or is located in a foreign jurisdiction. The presence of robust insurance coverage can result in the buyer reducing the amount of funds it requires in the seller’s escrow account.

While R&W insurance can provide many benefits for the parties in an M&A transaction, it is limited to covering breaches of representations. Other types of breaches that may arise under a merger agreement, such as covenant breaches, purchase price adjustments, and breaches of payment obligations, would not be covered by the R&W insurance policy. The policy should also be reviewed carefully for coverage exclusions or limits. Furthermore, while the R&W insurance will generally provide coverage for tax representations in the merger agreement for post-closing periods, R&W insurance policies may not provide coverage for pre-closing taxes.

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