Mergers and Acquisitions – Representations and Warranty Insurance Policies

By: Geoff Cowling

The ability to insure risks associated with the acquisition or divestiture of an entity or its assets is an evolving area in the risk and insurance field.

In the past, a buyer or a seller had to rely solely on their own due diligence process and accepted risks associated with a transaction as a risk of doing business.  As with any transaction there is the potential for malfeasance, misrepresentation, innocent error or risks deemed too great to accept for either the buyer or the seller.

Representations and Warranties insurance products are available to mitigate these risks, with their primary goal being to facilitate the closing of a transaction between parties by offsetting the risks that one party or the other may deem too onerous.

Policies are available for either the buyer or the seller and can be purchased by either.  Sellers’ and Buyers’ policies are designed to cover the general representations and warranties as well as any tax covenants or representations.

When would insurance be used?

• To enable a transaction to proceed
• To provide adequate level of warranty recourse to the Buyer
• To enable the Seller(s) to utilize sale proceeds immediately (allow investment funds to make distributions to investors)
• Where there is a mismatch in the expectations of the parties on risk allocation
• To allow the parties to ‘get comfortable’ with their negotiated position
• To remove risks associated with cross-border acquisitions

Seller Side Policies

Cover is written to respond directly to action for breach of warranty or tax covenant in the sale and purchase agreement (SPA) by sellers/warrantors:

• Defence costs cover included within policy
• Interests aligned with Insured – i.e. to defend a claim vs. buyer
• Benefit from assistance/experience of Insurer but give away full
• flexibility/discretion on claims management
• There must be a liability which is being insured

Buyer Side Policies

Cover is written as an addition to or, at times, alongside the liability of the seller/warrantor under the SPA.  A Buyer side policy will:

• Protect the buyer against risk of fraud by the seller
  • Policy gives the buyer the benefit of simply claiming against the Insurer, a single entity with a S&P A+ rating
• Increase financial recourse available or extend time periods under the SPA, or both
• Mirror many of the SPA provisions but not seller’s cap and time limitations
• Policy retention typically set at seller/warrantor cap
• Can be structured to achieve a seller “clean exit”  i.e. Little or no post-close liability for seller – subject to adequate disclosure and the buyer retaining some first loss liability;
• Can remove need to pursue management that may stay on after the transaction closes
• Avoid private equity being ‘tarnished’ by pursuing management

What is not covered by a Reps and Warranties Policy:

• Liabilities beyond the scope of the representations and warranties contained in the SPA.
• Actual knowledge of the insured (insured being the recipient of claim proceeds under the policy)
• A reps and warranties policy is not a substitute for:
  • Proper disclosure by Seller
  • Proper due diligence by Buyer
  • Proper negotiation

The Process

As with any insurance product the more information and time available, the better.

Insurers will sometimes charge a due diligence fee which can be credited against premium when a policy is purchased. They will require access to the data room and will participate in non-disclosure and confidentiality agreements on the same basis as any transactional advisory firm.

As the cover will closely mirror the SPA, regular updates and any changes to the SPA will be required to be notified prior to binding cover.

For more information on if Reps and Warranties Insurance may be applicable to your operations please contact a member of the Iridium team.