Representations and warranties insurance (RWI) is designed to cover certain breaches of representations and warranties made in business merger and acquisition (M&A) agreements. RWI has emerged as a preferred tool by executive management to reduce transactional risks.
Policies can be purchased by either the buyer or the seller in an M&A transaction. Buyer-side RWI policies provide first-party liability coverage to protect buyers from financial loss due to misrepresentations by sellers—whether intentional or accidental—such as misrepresented financials, unknown third-party claims over intellectual property, and failure to obtain environmental or legal permits. On the other hand, seller-side policies offer liability protections against accidental misrepresentations in purchase agreements.
Benefits of RWI for buyers include:
- Appearing as a more attractive bid — In an auction situation, RWI reduces or eliminates the need for the seller to establish an escrow to cover any post-sale contingencies and liabilities. As a result, the buyer’s bid will look more appealing.
- Adding additional time and protection — RWI policies allow for extended time frames for a buyer to uncover specific problems with the general representations of the acquired business. The buyer can also purchase insurance at higher amounts beyond the negotiated indemnity cap.
- Enhancing protection — Having RWI coverage in place generally makes collecting indemnification easier and more certain.
It can also be advantageous for sellers to purchase RWI. Benefits of a seller-side policy include:
- Reducing or eliminating the need for an exclusivity of remedies (EOR) provision — In a traditional M&A transaction, an EOR provision is a guideline for each party’s rights regarding handling claims. However, RWI can reduce or eliminate the need for these provisions, resulting in a less complicated transaction.
- Reducing or eliminating the need for an escrow — An escrow can decrease the seller’s shareholder proceeds at the closing. RWI allows for the immediate distribution of more of the proceeds.
- Allowing for a cleaner exit — M&As can get messy quickly since it’s unlikely for both parties to agree on every detail of the transaction. RWI coverage can provide a seller with fewer contingent liabilities, resulting in a cleaner exit.
RWI insurance is a tool increasingly utilized in M&A transactions. As a result, it is beneficial for corporate executives to familiarize themselves with the product and its benefits. For more risk management guidance, contact us today.