Maximizing the Value of Your R&W Insurance Policy

by McGuireWoods LLP
Contact

The global M&A boom has spurred an increase in the use of representation and warranty insurance (“RWI”), which is designed to protect the insured party against breaches of a sellers’ representations and warranties in a corporate acquisition or merger agreement. RWI is increasingly used by buyers to differentiate their bids in an ultracompetitive marketplace, as well as by sellers look to maximize returns and minimize post-closing risk.  A purchase agreement that incorporates a RWI policy can influence a seller’s ultimate decision when selecting a buyer.

For private equity-backed portfolio companies, incorporating RWI in a deal allows sellers to pass profitable returns to the fund’s limited partners and can reduce or eliminate claw back distributions from the LPs when indemnification claims are subsequently made.  RWI also gives sellers the full value of the sale without tying proceeds up in escrows, holdbacks, and can reduce or eliminate entirely future indemnification claims.

For buyers, a RWI policy helps to eliminate the need to decide whether to make claims against “friendly” indemnitors (e.g., management), and can often result in a buyer-favorable purchase agreement in a seller-favorable climate.  RWI can provide additional indemnification limits above the terms of the purchase and an extended period of time to recover for any breaches beyond the survival period.

Yet at each stage of the acquisition, buyers regularly fail to maximize the value that the RWI policy can provide.  By utilizing the RWI policy at each stage of an acquisition, a buyer can add value to its acquisition.

How to Maximize the Value of the RWI Policy

1.   Consider the Details of RWI in Your Letter of Intent

Although the procurement of RWI is now routine during the negotiation of the letter-of-intent, the parties often limit their focus on the RWI policy to the mere requirement that the buyer will obtain a policy, without negotiation of the specifics of how the coverage will apply, much as buyers routinely obtain but do not negotiate D&O tail policies.  Occasionally the parties negotiate the desired size of the retention insofar as it relates to the size of an escrow.  However, buyers regularly fail to consider simple but important concepts that can increase their risk and limit their rewards:

  • Is the RWI policy the sole measure of recourse (other than the escrow)?
  • Who bears the risk of policy exclusions?
  • Who pays for the policy?

Considering these questions during the LOI phase gives buyers increased certainty regarding the overall indemnification package and takes these items off of the table as future negotiating chits.

2.   Use the RWI Policy to Push During Diligence

 RWI underwriters rely on the due diligence performed by the buyer. If the use of RWI is a facet of the deal, the due diligence by the buyer must be adequate and the seller must be ready to provide greater access to data in order to facilitate the required due diligence. The nature of the target’s operations will drive the depth of the diligence.  For example:

  • Is a Phase I Environmental Report needed to avoid an exclusion based on environmental liabilities?
  • How much of the target’s business relies on key contracts, customers or suppliers?
  • What are the target’s billing practices, particularly billings to federal, state or local government agencies?
  • Is the target susceptible to wage and hour claims?

The non-binding letters of intention received from the RWI underwriters will highlight the particular area of concern, based on the underwriter’s review of the initial purchase agreement and LOI. If the RWI is the sole recourse, the buyer must be vigilant that the due diligence conducted will be sufficient to address the underwriter’s concerns. Likewise, to the extent that the seller remains on the hook for any excluded representations or warranties, providing access to this information is vital to reducing the chances of a deal-specific exclusion.

Moreover, in the current competitive deal landscape where sellers seek to pressure buyers into expediting their diligence and thereby limit the scope of diligence, a smart buyer will leverage the RWI underwriter’s need for in-depth diligence to obtain a level of diligence satisfactory to the buyer and the RWI underwriter.

3.   Use the RWI Policy to Negotiate the Purchase Agreement

 A well-negotiated RWI policy can provide greater protections to buyers (and sellers) than they might otherwise get without engaging a RWI carrier.  Buyers can negotiate a more fulsome representations and warranties package from the sellers since the vast majority of the risk of a breach is on a third-party insurance carrier.  This typically means lower materiality thresholds and longer look-back periods.

For sellers, the RWI policy can afford a shorter escrow period, lower escrow limits and provide the sole recourse for any indemnification obligations beyond any escrow. Because there is another source for the indemnification obligations, sellers should be willing to open up the representations and warranties.

4.   Address Exclusions

 When armed with the proper diligence, buyers can successfully negotiate with RWI underwriters to reduce or eliminate deal-specific exclusions. Where a buyer has conducted sufficient due diligence, buyers and their counsel should be unwilling to accept exclusions related to unknown risks, and should push back against such exclusions.  A buyer that has conducted in-depth diligence has the leverage to successfully push back against exclusions related to areas of a company where there may be increased potential for risk (e.g., risks related to a high customer concentration) but where there are no identified reasons for concern. In addition, the use of schedules to identify the known risks often reduces the need for broad and open exclusions.

Conclusion

As private M&A continues to skyrocket at a record pace, buyers and sellers increasingly use representations and warranties insurance to transfer risk to third party insurance carriers.  Yet in many cases buyers fail to realize the full value of the policy.  Deal lawyers and their clients should be leveraging RWI at each stage of a transaction to better mitigate post-closing risks and to maximize the RWI policy’s overall value.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© McGuireWoods LLP | Attorney Advertising

Written by:

McGuireWoods LLP
Contact
more
less

McGuireWoods LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.