In the M&A marketplace, crowded auctions frequently leave buyers standing at the altar, wondering why a seller has chosen to go with what otherwise appears to be an inferior bid. Perhaps, however, the winning bid possessed something other than a high purchase price.
More and more, bidders are standing out with creative uses of contingent liability insurance policies when placing a bid for an acquisition. Representations and warranty insurance (RWI), a type of contingent liability insurance, provides coverage for certain breaches of a seller's representations and warranties made in the context of an M&A transaction. Recently, Lockton Companies reported an increase of 70 percent in the number of policies issued in one of its key markets from 2011 to 2013. Successful buyers have also begun to more freely discuss their inclusion of RWI policies as part of their bids and the likelihood that such inclusion helped them win the deal.
As the use of RWI policies continues to increase, bidders may find that they must include such policies in their bids to keep up with their competition.
RWI policies are useful where a seller and a buyer are unable to agree on which party, or to what extent a party, should have exposure for certain risks related to the business (which would manifest themselves as unintentional and unknown breaches of representations and warranties in the transaction documents). RWI policies are also useful where a seller is looking to maximize the cash it takes away from the closing table, reducing or eliminating the amount of purchase proceeds that a buyer would otherwise require be held back or placed in escrow to cover potential post-closing indemnification claims. Finally, buyers can use RWI policies to obtain enhanced indemnity coverage beyond what a seller is otherwise willing to provide.
In their early years, RWI policies could bog down an M&A transaction with slow underwriting, high premiums and minimal coverage. Today, the underwriting process is smoother, the premiums are more competitive and carriers are generally more responsive to the needs of M&A parties.
The process for obtaining an RWI policy begins with securing proposed terms from the market and selecting a carrier. An underwriting fee is generally due at this time. The carrier will then spend a few weeks in the underwriting and policy preparation phase, followed by finalizing the policy along with payment of the premium. Including certain representations, such as taxes and environmental, can slow the timing, and, as a result, RWI policies should be considered early in the M&A process.
The underwriting fee typically ranges from $5,000 to $50,000 and premiums generally range from 3 to 5 percent of the insured amount. Some carriers will not write a policy for less than a premium of $150,000 to $250,000. Retention (or deductible) levels, an important factor in pricing and the overall structure of the policy, can range from approximately 1 to 5 percent of the transaction amount, with some carriers requiring a minimum retention of anywhere from $150,000 to $1 million. As would be expected, premiums and retention levels are negotiable to some extent, with the ability to obtain lower retention levels in exchange for higher premiums.
As with all insurance products, the fine print can ultimately determine the true value of a policy. Buyers and/or sellers who purchase a policy anticipating coverage for forward-looking representations and warranties in a purchase agreement will be disappointed when their claim is denied because of the "exclusions" in the policy.
In addition to exclusions for forward-looking representations and warranties, other common exclusions include matters known to a buyer or seller, damages calculated using a "multiplier", consequential and other types of damages and injunctive, equitable or other non-monetary relief.
RWI policies also generally include the equivalent of an "anti-sandbagging" provision, excluding coverage for breaches of representations and warranties that are known to the buyer (assuming the buyer is the insured party).
Anyone considering purchasing an RWI policy should spend considerable time reviewing the proposed policy and the "fine print" to understand variables such as retention, coverage limits, policy periods and exclusions.
RWI policies can be a useful tool for buyers to utilize in their bids to help stand out from others and potentially increase the perceived, or real, deal value for the sellers.
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.