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Representations and Warranties Insurance in Deals: What Is It and Why Would You Need It?

Merger and acquisition agreements contain representations and warranties of the sellers as a way to understand and allocate the risks. Generally, the representations and warranties survive for a time period after the closing of the transaction and if the buyer learns of inaccuracies in the representations and warranties before they expire, the buyer could bring an action against the seller to recover for damages as a result of the inaccuracy. Buyer and sellers can use representations and warranties insurance (R&W Insurance) to protect against these risks and facilitate negotiations of agreements so that the scope of the representations and warranties and indemnification obligations do not become a sticking point in negotiations. Since these are some of the most negotiated provisions of agreements, using R&W Insurance can also decrease the amount of legal fees spent in such negotiations.

Sellers benefit from R&W Insurance because they can be more certain of retaining the proceeds they receive from a sale. The parties may be able to reduce or eliminate escrows of proceeds. Sellers are indemnified by the insurance company for defense costs and losses resulting from successful claims.

Buyers benefit because they receive the comfort of having a source of recovery if problems arise. In particular, buyers may be able to obtain relief directly from an insurance company without having to pursue the seller so they don’t have to bring an action against a seller that may still be involved in the operation of the company.

Originally, representations and warranties insurance was perceived as prohibitively expensive when it was introduced in 1997. Now, that perception has changed, and many entities commonly utilize R&W Insurance as an essential part of every transaction. The sweet spot for insurance is generally for deals in the $20 million to $1.5 billion range, although there are ways in which R&W Insurance could be a viable option in a $10 million transaction. Premiums are usually in the two to four percent range for each dollar of coverage, but the premium costs can vary. Buyer policies are generally more expensive because the seller is deemed to have more information in its possession and provides less risk of a breach.

Once a decision has been made to acquire a policy, care must be taken to carefully examine and understand the scope and exclusions of the policy. For example, seller policies typically exclude coverage for fraud whereas buyer policies do not. Policies also include a deductible in the one percent to high three percent range. Approximately seven to ten insurance companies currently provide representation and warranties insurance.

Whether you are a purchaser or a seller, it is important to understand the benefits and risks associated with representation and warranty insurance. The availability of such insurance may mean the difference between closing a deal or not, and if it closes, being able to eliminate much of the uncertainty that often follows the end of a transaction.

The firm has several relationships in the insurance community that innovated and provides this insurance as well.

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