Representations and Warranties Insurance: Advantages and Disadvantages
Both buyers and sellers of businesses continue to use representations and warranties insurance (“R&W Insurance”) as a way to insure losses associated with breaches of representations and warranties in private, middle market M&A transactions. In an earlier post, we explained best practices when obtaining such a policy. Here, we summarize the advantages and disadvantages of using R&W Insurance from both a buyer’s and a seller’s point of view.
Buyer Advantages:
- From a buyer’s perspective, the primary advantage of using R&W Insurance is facilitating the deal. R&W Insurance gives a buyer a competitive edge in an auction because it allows the buyer to accept a low seller indemnity package without assuming all of the risk. Thus, R&W Insurance keeps the deal moving towards closing.
- R&W Insurance also allows for longer survival periods for general representations.
- When there are multiple or foreign sellers, having R&W Insurance avoids collection issues in the event a buyer has an indemnity claim.
- Today, the underwriting process for R&W Insurance is fairly streamlined and straightforward. This makes it simple for a buyer to obtain R&W Insurance.
Buyer Disadvantages:
- Sometimes R&W Insurance insurers exclude certain items from coverage (e.g., items identified during diligence and issues that arise after signing but before closing). Exclusions can lead to longer, and sometimes more heated, negotiations.
- R&W Insurance can sometimes be costly for a buyer. Usually, the buyer and seller will split the R&W Insurance policy premium. Other times, the buyer is responsible for the entire premium.
Seller Advantages:
- A seller’s primary advantage when using R&W Insurance is the limit on the seller’s post-closing liability for a breach of a representation or warranty in the purchase agreement.
- R&W Insurance gives certainty to the amount of proceeds a seller will receive in the transaction.
Seller Disadvantages:
- Some strategic buyers and foreign buyers (who are less familiar with the practice) are unwilling to use R&W Insurance.
- A buyer may seek special line-item indemnity for items the insurer excludes from the R&W Insurance policy that mitigate the benefits of the policy.
- As a general matter, most R&W Insurance providers will not begin the underwriting process until a bidder has formal exclusivity.
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