Forecasts of increased M&A activity, combined with a global economic climate where risk aversion is the name of the game, present an opportune moment for examining M&A insurance as a viable means of reducing risks in business transactions.
The most common type of transaction insurance is Representation and Warranties (R&W) insurance, which targets the net liabilities facing parties in M&A deals.
Intended to help smooth negotiations and closings, R&W insurance seeks a balance between buyers’ concerns for losses resulting from breaches of representations and warranties, and sellers’ interests in liability protection. As an alternative to traditional mechanisms of risk management (e.g., escrows, holdbacks, indemnities), R&W insurance addresses both buyer and seller concerns.
Benefits to the parties include:
- Indemnification for breaches of representations and warranties given by the seller;
- Additional means of protection against indemnity collection concerns with respect to the financial solvency of the seller;
- Protection of key relationships;
- A mechanism to address potential conflicts with seller-side management who will remain employed by the target following the transaction; and
- Strategic positioning opportunities to distinguish one’s bid from competitors.
- Protection from post-transaction claims for indemnification arising from unknown risks or contingent liabilities;
- Ability to reduce the reliance on retaining funds in escrow;
- Ready opportunities to distribute sale proceeds to investors or towards existing debt; and
- A means of expediting the transaction so as to potentially realize an increased return.
In addition to party protections, R&W insurance can be a useful and flexible negotiating tool. It can be purchased with respect to all, some, or even one representation and warranty, and may be used with other M&A insurance tools such as tax opinion indemnity insurance and litigation containment insurance to facilitate transactions.
R&W insurance can’t be a substitute for proper processes of disclosure by the seller or due diligence by the buyer, but it may be able to make or break the success of an M&A deal, particularly in light of the ongoing challenges in the current economic climate.
Though historically underutilized, R&W insurance may emerge as the latest tool in advancing M&A activity.
Jenny Yoo, a summer student at Norton Rose Canada, also contributed to this post.