For the first time, the American Bar Association’s Private Target Mergers and Acquisitions Deal Points Study (the Study) includes data points on the use of representation and warranties insurance in transactions. The Study analyses publicly available purchase agreements for transactions for which purchase agreements were executed and/or completed in 2016 and the first half of 2017 that involved private targets being acquired by public companies in the US (the Agreements).
Representations and warranties insurance (RWI) is a tool increasingly used by buyers and sellers in the context of mergers and acquisitions. As previously discussed on this blog here and here, RWI offers parties the ability to successfully negotiate deals by reducing the parties’ exposure to losses attributable to breaches of the seller’s representations and warranties in the purchase agreement. From the buyer’s perspective, this tool offers a way to enhance its protection from breaches of representations and warranties, preserve relationships with sellers that remain involved with the target post-closing, either as key employees or otherwise, and to win competitive auctions with reduced seller indemnity and escrow obligations. From the seller’s perspective, the use of a policy facilitates a clean exit, expedites the sale process and protects passive sellers not involved with the day-to-day operations of the business.
Analysis of RWI usage in 2016 and 2017
RWI was contemplated in 29% of the Agreements and, not surprisingly, 93% of those policies were buy-side policies. Buy-side policies provide the buyer with insurance coverage for losses resulting from breaches of the seller’s representations and warranties and are more prevalent than sell-side policies which provide the seller with insurance coverage for losses payable by the seller to the buyer for breaches of its representations and warranties. Underwriting sell-side policies presents greater challenges for underwriters and their advisors to get comfortable with the seller’s representations and warranties given the lack of legal and financial due diligence reports which are typically provided by the buyer’s professional advisors in the context of underwriting buy-side policies. Although buy-side policies are more prevalent, the buyer and target shared the cost of the policy in 43% of Agreements that included reference to RWI, while the buyer paid for the policy in 45% of the Agreements and the target paid for the policy in 8% of the Agreements.
Data collected in the Study on the size of the retention was scarce given that 88% of the Agreements were silent on this point. 10% of the Agreements provided for a retention that was larger than the basket, 3% provided for a retention that was equal to the basket and no Agreements provided for a retention that was less than the basket.
The Study revealed the following with respect to timing of coverage and closing conditions/covenants:
- 48% of polices were expressly bound at signing
- 50% of the Agreements included RWI as a closing condition
- 58% of the Agreements included pre-closing covenants related to RWI
The Study further revealed the following with respect to indemnity baskets and caps:
- Baskets (as a percentage of transaction value) tended to be smaller in Agreements that included reference to RWI:
- Of the 45% of Agreements that provided for a basket equal to 0.5% or less of the transaction value, 38% included reference to RWI
- Of the 50% of Agreements that provided for a basket of >0.5% to 1% of the transaction value, only 16% included reference to RWI
- The mean deductible was 0.94% in Agreements with reference to RWI and 0.64% in Agreements without reference to RWI
- The mean basket for “at first dollar” tipping baskets was 0.36% in Agreements with reference to RWI and 1.02% in Agreements without reference to RWI
- The mean for all basket types (other than combination baskets with both a deductible and at first dollar tipping threshold) was 0.77% in Agreements with reference to RWI and 0.84% in Agreements without reference to RWI
- Caps (as a percentage of transaction value) tended to be smaller in Agreements that included reference to RWI as well:
- The mean indemnity cap was 5.77% in Agreements that did include reference to RWI and 14.70% in Agreements that did not include reference to RWI
While the Study is limited to public company acquisitions of private targets in the US and does not distinguish between transactions for which RWI was obtained and transactions for which RWI was not obtained where the purchase agreements were silent with respect to RWI, these findings demonstrate how RWI may be used to expedite negotiations between buyers and sellers and to distinguish a buyer’s bid in a competitive auction.
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