Buyers and sellers are using representations and warranties insurance more frequently in M&A transactions as a means to enhance bids in competitive auction processes and to limit exposure to post-closing indemnification liabilities. Representations and warranties insurance has been previously discussed on this blog generally (see here, here, and here), including how it can be beneficial to buyers and sellers in transactions by providing access to the insurance industry’s capital and allowing the transfer of certain transaction-related risks in M&A deals to the insurance market.
Representations and warranties insurance coverage can, however, be tailored to mitigate specific types of risk in transactions. Insofar as environmental risk has become a more prevalent concern in M&A transactions, environmental liability insurance is gaining popularity amongst both buyers and sellers. In pushing for environmental insurance coverage, buyers seek to avoid unknown environmental liabilities not factored into the purchase price and sellers seek to avoid continuing environmental liabilities of the divested company/asset.
Environmental liability insurance, however does not cover all environmental risks – it is not a “catch all”. Marsh & McLennan Companies published a report that highlights nine considerations that must be taken into account when using representations and warranties insurance to cover environmental risks:
- The coverage is expected to pay for the cleanup of unknown, pre-existing conditions.
- New conditions coverage is not provided.
- Consequential losses, such as third-party bodily injury, third-party property damage, business interruption, and natural resource damages my not be covered. Coverage for non-owned disposal sites and divested properties is also not guaranteed.
- Policy terms vary from one to six years.
- Self-insured retentions are typically 1.5% to 2% of the transaction value.
- Limits and self-insured retentions are shared with other representations and warranties-related risks.
- Coverage applies to environmental laws at the time the deal is closed and does not cover changes in laws going forward.
- There is no duty to defend under representations and warranties insurance policies, although defense costs will be paid once a breach has been determined to have occurred.
- High-risk industries such as chemical, petrochemical, and heavy manufacturing are not a target class for environmental coverage under a representations and warranties policy.
It follows that although representations and warranties environmental liability insurance is becoming more common in M&A transactions, buyers and sellers must understand that it may not provide sufficient coverage in all circumstances. Additional standalone insurance may be necessary in high risk transactions, and in all cases parties must consider the nature of the deal at hand and negotiate the insurance coverage they deem necessary.
The author would like to thank Robyn McLaren, articling student, for her assistance in preparing this legal update.
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