Protect M&A with R&W Insurance
By Michael Williams with BDO, a partner of the M&A Leadership Council
The use of representations and warranties (R&W) insurance in mergers and acquisitions has grown significantly over the past several years and has become an increasingly integral component of the transaction process. This article focuses on how buyers and sellers use R&W insurance for both strategic and risk management purposes to improve deal execution by accelerating the parties’ ability to reach agreement, thereby expediting the close of a transaction.
What is R&W insurance and its key features?
Loss Insurance: In general, R&W insurance shifts risk to an insurer by providing coverage for indemnification obligations resulting from breaches of representations and warranties made in a transaction agreement. R&W insurance principally is designed to cover risks and exposures that are unknown at the time the policy is bound. It protects the insured from losses that become known after the closing which were unknown or unanticipated at the time of the signing of the deal. The risk of loss often arises from reliance on the seller’s representations about financial statements, rights to ownership or use of intellectual property, pre-closing tax indemnities for potential exposures, or lack of compliance with laws or regulations, to name a few.
Replacement for Holdbacks or Backstop for Specific Claims: R&W insurance may serve as the recourse and substitute for escrows or other forms of purchase price holdbacks. Contingent liability insurance, including tax indemnity insurance, may be used in conjunction with R&W insurance to provide coverage for one or more known exposures in an M&A transaction that may be expected to arise after the closing of the transaction. A combination of R&W insurance and contingent liability insurance could attempt to place the insured in approximately the same risk of loss position as intended to be covered under the indemnities and by the proposed holdback amounts and mechanisms. Contingent liability insurance usually requires an estimate of the exposure amount and an assessment of the probability of the occurrence of the matter insured. R&W insurance and contingent liability insurance may be negotiated to be either the sole source of recovery for exposure obligations or as a back-stop to a failure to satisfy the obligations of a transaction agreement.
