by Geoffrey Lee
Representations and Warranties Insurance (RWI) is a strategic tool utilized in merger and acquisition transactions to transfer risk of financial loss for seller representation and warranty breaches in a purchase agreement to an insurer.
RWI has a number of well-known benefits for both buyers and sellers but the focus for this post is on highlighting where RWI could add significant value over uninsured deals in protecting ongoing business relationships between parties post-closing of a transaction. This is an area that is often overlooked but a crucial component of deal success.
In the event of a breach of a representation or warranty, a buyer must consider the commercial realities of bringing a contentious action against the seller regardless of a claim's legitimacy. In many cases there is significant risk, particularly for public proceedings, that such an action could damage goodwill with management and employees or jeopardize existing relationships with established customers and suppliers of the business. With a buy-side RWI policy, the insurer stands in as a neutral and credit worthy third party to handle any potential representation and warranty claims confidentially with the buyer.
Some common deal scenarios which RWI can help to address post-closing include:
Partial acquisitions
When a buyer acquires less than 100% of the business there will always be the need to manage on-going relationships between the new acquirer and existing vendors. A claim for a breach of a representation or warranty raises the potential for contentious disputes amongst the parties that could disrupt the post-integration process at a time when fostering goodwill with new business stakeholders should be a priority.
Founder divestments
Where founder led businesses are sold with existing obligations to work within the business post-closing, the drivers for its continued success are intrinsically linked to those providing the representation and warranties under the purchase agreement. Claims against the founder or management shareholders who are crucial to the business could be severely detrimental to the operation of the acquired business and its key customer and supplier relationships.
Large corporate divestments
In today's economic climate, many transactions are undertaken to streamline businesses by divesting or spinning-off non-core assets. Large corporate groups often require complex transitional service arrangements whereby buyers and sellers continue working together post-closing. A claim for a breach of a representation or warranty could sour this relationship and significantly impair the acquired business during this important transition period.
Representation and warranty breaches in an uninsured transaction can put significant strain on relations where post-closing obligations between parties exist. Accordingly, M&A participants should consider the value of RWI as a helpful risk mitigation tool. Beyond offering secure financial recourse for a buyer, a RWI policy may help provide additional peace of mind that important relationships can continue to be maintained well beyond the parties signing on the dotted line.
Authored by Geoffrey Lee, Liberty GTS
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.
