In recent years, there has been a surge in using reps & warranty insurance in M&A, especially in private deals. Buyers and sellers can save significant time and money using reps and warranties insurance. This article will discuss how to approach reps and warranties insurance, featuring Josh Holleman, Partner at Cooley LLP.
"Reps and warranties insurance is more advantageous to traditional indemnity structures because it's easier to recover against an insurer compared to a seller." – Josh Holleman
In M&A, sellers always make a list of representations (reps) and warranties about the current state of their business, often found in the definitive agreement. These statements are presumed to be accurate and are used to persuade buyers to acquire a company. A seller will be held liable for any breach of the reps and warranties.
With reps and warranties insurance, the insurer replaces the seller as the liable party for breaches, which reduces the chances of post-close risks for the seller. As good as it may sound for the seller, reps and warranty insurance also benefits the buyer.
Josh recommends reps and warranties for most deals but also states that they are not applicable for every transaction. Here are instances where reps and warranties insurance is not suitable.
Contact a broker at least two weeks before finalizing a deal. Hiring a broker before submitting a bid or LOI can provide more certainty about reps and warranties insurance availability.
The insurer's diligence aims to support, not replace, the buyer's diligence. The underwriter focuses on historical risks and anything that could make any representations untrue. In contrast, the buyer focuses on things that could create problems or exposure in the future.
For this reason, underwriters expect the buyer to do thorough due diligence in critical areas, and their job is to confirm the buyer's efforts. Underwriters also want to ensure they get their hands on any diligence report from the buyer's advisors.
Insurances are like contracts and must also be negotiated. Insurers will want to protect themselves from massive liabilities, while buyers seek maximum protection. There are two commonly negotiated parts of reps and warranty insurance:
1. Exclusions - These are things not included in the insurance policy. There are two types of exclusions: standard exclusions and deal-specific exclusions.
a. Standard exclusions are typically excluded from almost every reps and warranties insurance policy, such as net operating losses, wage and hour issues, underfunded pension liabilities, and forward-looking reps.
b. Deal-specific exclusions are known issues or problems identified in diligence instilled in the target company's industry.
2. Deemed edits - The insurer is looking to edit the purchase agreement to limit the scope of specific reps.
If a particular risk is excluded from a policy, the buyer would want the seller to backstop any potential exposure. But, conversely, the seller must watch out for subrogation, which allows an insurer to go after them if they commit fraud.