In the complex and often turbulent waters of mergers and acquisitions (M&A), participants are increasingly turning to representations and warranties insurance (RWI) as a means to facilitate smoother transactions and mitigate risks. This innovative insurance product can play a pivotal role in addressing the concerns of both buyers and sellers, by providing protection against financial losses arising from breaches of representations and warranties made in the transaction documents.
What is Representations and Warranties Insurance?
Representations and warranties are assurances given by sellers regarding the condition of the business being sold, including its financial performance, legal status, and the validity of its assets and liabilities. RWI serves as a safety net for the parties involved in M&A transactions, offering financial protection against losses resulting from inaccuracies in these statements.
For Buyers: A Tool for Risk Mitigation
For buyers, RWI offers an added layer of security, enabling them to recover losses directly from the insurer, rather than pursuing the seller, in the event of a breach. This is particularly beneficial in deals where the seller’s indemnity might be limited or where the buyer prefers not to enforce claims against a new business partner. Furthermore, RWI can enhance the attractiveness of an offer during a bidding process, by reducing or eliminating the need for a traditional indemnity escrow, thereby making more of the purchase price available upfront.
For Sellers: A Path to a Cleaner Exit
Sellers benefit from RWI by limiting their post-closing liability exposure, facilitating a cleaner exit from the business. This can be especially valuable in situations where the sellers are individuals or private equity firms looking to distribute proceeds to their investors. By transferring the risk to an insurance company, sellers can reduce or eliminate the need for extensive escrow arrangements, freeing up more of the sale proceeds at closing.
Navigating the Challenges
Despite its benefits, securing RWI coverage requires careful navigation. Insurers will conduct a thorough underwriting process, scrutinizing the due diligence performed by the buyer and the veracity of the representations and warranties. The cost of RWI, typically borne by the buyer or split between the parties, can vary depending on the risk profile of the transaction and the scope of coverage desired.
Moreover, RWI policies come with certain exclusions and limitations, including known issues identified during due diligence, which are not covered. Therefore, parties must carefully assess the policy terms to ensure that they align with the transaction’s risk profile.
As M&A transactions continue to evolve, the strategic use of representations and warranties insurance has become an indispensable tool for managing risk and facilitating deal-making. By offering a bridge over potential post-closing disputes, RWI can help ensure that M&A transactions move more smoothly and swiftly to completion. For parties engaged in these deals, understanding and effectively leveraging RWI can be a key factor in achieving successful outcomes.
