This article is a continuation of our last blog where we cited the seller side examples of when representations and warranties insurance would come in handy. Now we’ll discuss buyer-side examples and discuss what you should expect from the policy.
If you want to acquire a business or assets, following are examples of situations that may warrant the purchase of a reps and warranties policy:
- Bid enhancement. If you’re involved in a competitive auction process bidding on prime assets, you can distinguish your bid from others by arranging for a reps and warranties policy to replace the seller’s indemnity. Using this insurance could enhance the ability for you to win this auction.
- Public M & A indemnity. When looking to acquire a public company, you can arrange for reps and warranties policy to provide the indemnity that is generally not available because the publicly held nature of the target.
- Distressed M &A indemnity. When acquiring a distressed target, you can use a reps and warranties policy to protect you from any credit risks the company would later expose you to.
Now that you know examples of when reps and warranties insurance would come in handy, let’s look at what it should cover. Each policy is unique, but typically covers losses from claims made by buyers for any breach of, or an allegation of inaccuracy in any of the representations and warranties the seller made in the purchase and sale agreement (PSA). You can have a rep and warranties policy tailored to a specific reps or warranty, but the coverage is generally offered on a blanket basis to cover all reps and warranties.
The definition of loss in the policy should mimic the extent of the indemnity negotiated in the PSA and can include defense costs, fees, and expenses incurred by the insured when defending a claim brought by a third-party which results from an alleged breach of a representation or warranty. These policies usually have a self-insured retention. The amount of retention varies, but usually is relative to the amount of the hold back negotiated.
Reps and warranties policies do not cover known issues that are discovered during the due diligence or described in the disclosure schedules. They also do not cover the purchase price, the net worth, or similar adjustment provisions contained in the PSA. There are additional exclusions on each policy. Be sure to carefully consider and negotiate the exclusions.
The policy is priced based on factors such as the nature of the risk involved, the extent of the due diligence performed by the parties, and the size of the self-insured retention. The charge is a percentage of the limits purchased. In the US a $20 million reps and warranties insurance policy can costs between 2% and 3.5% of the coverage limits.
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