Get the five key facts about Reps & Warranties insurance, which can cover some of the unforeseen costs caused by breaches of the seller’s representations.
Representation and Warranties insurance is a complex solution for a complex situation. There is nothing standard about the sale or merger of a company and so very little is standard about the insurance that supports it.
Reps and warranties insurance is essentially breach of contract cover designed to enhance or replace the indemnification given by the seller to the buyer.
In short, once the ink has dried on the merger or acquisition deal, R&W insurance covers some of the unforeseen costs caused by any breaches of the seller’s representations, whether it’s issues with their customer contracts, employment agreements, or the super secret recipe of their product.
There has been a large uptick in the amount of strategic buyers that use this product. In most instances, the General Counsel or the Risk Manager is often tasked with gaining an understanding of R&W Insurance and then explaining it in easy-to-understand terms to the rest of the team. At Woodruff Sawyer, we’ve developed the primer below for our clients to use when trying to explain this product internally as simply as possible.
Not wishing to sound boastful, but the reviews from our clients have included phrases like “brilliant,” “saved me a ton of time,” “just what I needed,” and “you’re the wind beneath my wings.” (Ok, that last one is a lie.)
In the interest of being helpful, here is a breakdown of the five key basics you need to know about.
Five Things You Need to Know About Reps and Warranties Insurance
So what do you really need to know about?
1. While either buyer or seller can be the insured, 90% of the policies placed are buy-side, protecting the buyer from any breaches of the seller’s representations. Why?
- Buy-side has additional fraud coverage which sell-side cannot provide.
- The insured buyer can pick a limit and time period beyond what the seller is willing to give.
- With this coverage, the buyer can avoid suing their newly acquired management team should any breaches or misrepresentations come up; they can go directly to the carrier instead.
- Buy-side allows the buyer to offer lower escrows or more competitive terms in an auction.
2. When drawing up Reps & Warranties Insurance, underwriters assess the risk on the following criteria:
- The nature of the seller’s representations and warranties, such as…
- The nature of the SPA terms and conditions such as multiples and consequential damage language, single of full materiality scrapes, sandbagging language,
- The quality of the due diligence. Underwriters wish to provide coverage for the truly unknown so they are looking to “diligence the diligence.”
3. The coverage is designed to cover all warranties. But certain exclusions are standard:
- Forward-looking warranties (for example, sales projections, etc)
- Purchase price adjustments
- The availability or usability of Net Operating Losses or R&D tax credits
- Certain areas that are difficult to get cover for, like FCPA, Union activity, underfunding of pensions, wage and hour, etc.
4. It’s a two-part process:
- Initial Non-Binding Indication
- This occurs one week from receiving the target financials, draft SPA, and any IM that has been prepared by the seller
- Costs nothing
- Underwriting
- $30,000 up front “diligence fee”
- Requires access to the data room, third-party diligence reports, and the buying team for conference call
- Takes one week but is dependent on the timing of the deal process.
5. Pricing: Two Alternatives
- Retention: This is expressed as a percentage of overall transaction size. The minimum is 1% of the transaction, meaning a $100 million transaction has a minimum $1 million retention. This can be in the form of a seller’s escrow, the buyer’s deductible, or a combination of the two.
- Premium: This is expressed as a percentage of the limit of coverage bought and is not related to transaction size. Currently, premiums are running 2.5–3.5% of the limit bought. For example, a $10m limit would mean a $250,000–$350,000 one-time payment for a six-year policy. It is worth noting that currently minimum premiums are running around $150,000–$200,000, so we generally don’t recommend this product if the insured is seeking less than $5 million of coverage.
I’d love to hear if you found this summary useful or if you feel there are ways we can improve it. This is a fast-growing market with a wide variety of knowledge levels. No matter your experience or your familiarity, Woodruff Sawyer is committed to helping everyone understand complex coverages as simply as possible.
Whiteboard Breakdown: How Reps and Warranties Insurance Protects an Acquisition
FAQs
Reps and warranties are assurances the seller provides regarding the factual statements about different aspects of the business. The seller assures the buyer about the financial performance, legal compliance, operational aspects, and other relevant business details.
How does reps and warranties insurance work? ›
Reps and Warrants Insurance. Reps and warrants insurance (RWI from now on) is a contract between the buyer (or the seller) and an insurance company whereby the insurance company will indemnify the buyer for loss resulting from a breach of reps and warrants.
What is representation and warranties insurance fundamentals? ›
R&W Claims
Breach is usually defined in the R&W policy as any breach of or inaccuracy in any representation or warranty in the transaction agreement. In general, an R&W policy will define the term loss as the amount the policyholder is entitled due to a breach under the transaction agreement.
What are basic representations and warranties? ›
Representations and warranties are assertions or assurances given by the parties to the agreement. While most purchase agreements contain representations and warranties from seller and buyer, the seller representations and warranties typically are the most extensive and more important.
Who typically pays for rep and warranty insurance? ›
Who Pays For Rep And Warranty Insurance? It is the Buyer in an M&A transaction who pays for the rep and warranty insurance premium most of the time. However, there are various instances when the premium is either shared between Buyer and Seller, or when the Seller picks up the bill.
What is an example of a rep and warranty? ›
Sample language: Seller represents and warrants that all facts presented in this Purchase Agreement, including without limitation all financial statements and [other documents] attached hereto, are true and correct in all material respects as of the Closing Date [date] of Purchase Agreement.
What does R&W insurance not cover? ›
RWI does NOT cover known, material issues uncovered during diligence or issues of which the buyer's deal team had actual knowledge, breaches of covenants in the purchase agreement (i.e., the requirement to pay off company indebtedness as of closing or the non-compete), purchase price adjustments and forward-looking ...
What are the exclusions for RWI? ›
Common RWI industry exclusions typically include known or expected breaches, purchase price adjustments, breaches of covenants, predictions or forward-looking statements, unfunded/underfunded pension plans, net operating loss (NOLs) and, for sell-side RWI policies, seller fraud; deal-specific exclusions and “deemed” ...
Who buys R&W insurance? ›
Both buyers and sellers can procure R&W insurance. One key difference between buyer-side and seller-side policies is that under a buyer-side policy, the buyer makes the claim against the insurer for the losses incurred because of the seller's breach.
What are fundamental reps and warranties? ›
Fundamental representations and warranties are defined in the purchase agreement for issues that are so material that the buyer would not have agreed to the transaction if the statements were false. These are not limited by the cap and basket.
The representations and warranties allocate risk between the parties and serve as the foundation for an indemnification claim in case of a breach or inaccuracy. A breach or inaccuracy of a representation or warranty can also provide the other party with a right to terminate or refuse to close the transaction.
What is the main difference between representations and warranties versus covenant? ›
The key difference among these words is temporal – past and present for representations; past, present, but mainly future for warranties; and mainly future for covenants. The remedies for a false representation, breach of a warranty or violation of a covenant also have differed.
What is the cap on reps and warranties? ›
This cap (the “General Cap”) is most commonly set at 10% of the total Purchase Price, although this may be higher or lower for certain deals. The cap on Fundamental Representations and Warranties is often set at up to 100% of the Purchase Price or even uncapped, and fraud claims are typically uncapped.
What are simple reps and warranties? ›
What are representations and warranties? Think of the representations in this section as promises that certain statements about the company are true, and think of the warranties as a promise to protect the buyer in the event that these statements are not true.
How long do reps and warranties survive? ›
A statute of limitations operates to limit the time during which a claim may be brought against a party. If a purchase agreement is silent as to survival, reps and warranties survive until the applicable jurisdiction's statute of limitations for claims for breach of contract lapses.
What does it mean to rep and warrant? ›
A representation is an assertion as to a fact, true on the date the representation is made, that is given to induce another party to enter into a contract or take some other action. A warranty is a promise of indemnity if the assertion is false.
What is a warranty in layman's terms? ›
A warranty is a guarantee or promise made by a manufacturer or similar party regarding the condition of their product. A warranty also refers to the terms and situations in which repairs, refunds, or exchanges will be made if the product does not function as originally described or intended.
What are reps and warranties in a purchase agreement? ›
Often referred to as “reps and warranties” are the statements of fact you make about your business during an M&A transaction. They serve as assurances to the buyer, providing crucial information about the state of your business and its various aspects.
