When we provided our thoughts on representation and warranty
insurance (RWI) this time last year (Getting a Deal to Closing with Transaction Insurance),
we anticipated that RWI would continue to grow in prevalence in the
Canadian deal-making. A year later and we can confirm that 2015 was
a banner year for the use of RWI in Canada and we expect this trend
to continue in 2016. Our view is that greater awareness of the
strategic value of RWI and heightened sensitivity to risk in the
current volatile economy will continue to lead parties to
investigate and obtain RWI in their deals.
The growing use of RWI to overcome deal hurdles illustrates the
maturing RWI market and the upside it provides in various of
transaction situations. Whether targeting improved indemnity
protection or longer survival of representations and warranties,
improving a bid in a competitive auction process, or being forced
into a RWI policy when no vendor indemnity is possible, there are
various ways RWI provides comfort to both vendors and
Fundamentals of RWI
RWI protects against unanticipated and unknown breaches of
representations and warranties. In its most basic form, RWI can
take the place of or supplement indemnity provisions and survival
periods in a transaction. Coverage is available for both
fundamental and non-fundamental representations and warranties and
can be provided for specific representations and warranties when
appropriate. This occurs in a situation where there is a mismatch
in the comfort level or risk tolerance between the vendor and
purchaser. The parties can then have recourse RWI to get the deal
Use of RWI
The following are a number of beneficial uses of RWI:
When targeting distressed assets or companies, rarely will
there be meaningful recourse against the vendor. Parties can employ
RWI to protect against such risk. In the context of a public
company target where limited representations and warranties are
given, comfort on liability is nonetheless sought.
Strategic application of RWI in an auction process allows a
bidder to remove or limit indemnity provisions and survival periods
to make its bid more favourable to a vendor. All things being
equal, a vendor will accept a bid that limits or removes indemnity
RWI can also be used as a negotiation strategy to break
deadlock. By moving risk away from a protesting party, RWI can
overcome barriers to closing by creating safety around higher
indemnity and longer survival periods.
RWI also eases collection concerns relating to a breach of
representations and warranties. As many RWI insurers are AAA rated
institutions, RWI can step in to provide protection where the
vendor is a high credit risk or a maturing fund selling assets to
Even if there is comfort the vendor will be able to pay claims,
purchasers may want to protect their relationship within newly
acquired management teams. Suing management teams, for example, for
claims while at the same time trying to grow the business is not
ideal. Moving claims to insurers keeps management happy and focused
while still providing comfort on any claim that could arise.
Issues to Watch
Because representation and warranty insurers piggyback on the
due diligence conducted by parties in order to assess the risks
associated with any given deal, RWI cannot replace due diligence.
The same applies to negotiating the underlying agreement and
particularly the representations and warranties the insurance will
be covering. RWI is not intended to fix sloppy work which is why
insurers take great efforts to determine that everything has been
due diligenced, negotiated and documented properly.
As RWI policies are bespoke and customizable based on numerous
factors, they require a lot of care and attention in drafting. The
definition of damages is critical to ensure that the appropriate
coverage is included. This can be a challenge considering the
numerous exclusions insurers typically include in their policies.
Besides damages and exclusions, additional issues for negotiation
include coverage amounts, term, deductible, premium and fees and
cost allocation between the parties. As coverage is typically
effective at closing, any risks that are realized in interim
periods between signing and closing will not be covered unless it
is expressly contemplated in the policy language. The final result
should be a policy which fulfills both the risk and cost
requirements of the parties.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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