Deals to buy or sell a business typically include statements of fact by the seller about the business. These representations and warranties are then combined with indemnification provisions to allocate risks and liabilities between the parties. Negotiating representations and warranties can be challenging, and deals often fall apart because the parties cannot reach an agreement. Representations and Warranties Insurance (RWI) can simplify negotiations and possibly save the deal.
RWI protects against unintentional and unknown breaches of a seller’s contractual representations and warranties. Though RWI is not a new insurance product, it’s increasingly being used by both buyers and sellers to shift liability to insurers for a fixed cost.
These policies cover many of a seller’s standard representations and warranties, such as statements about:
- Capitalization and debt;
- Accuracy of financial statements;
- Title to real, personal and intellectual property;
- Tax matters;
- Accounts receivable/payable and inventory;
- Employee benefits and compensation; and
- Compliance with laws and regulations.
In the past, RWI was typically reserved for buyers, but today RWI is used by both buyers and sellers. A ‘buy-side’ policy covers a buyer’s losses, including defense costs, due to the seller’s breach of a representation or warranty. A ‘sell-side’ policy covers the seller for defense costs and losses resulting from claims made by the buyer that the seller breached a representation or warranty.
Sellers can use RWI to:
- Reduce potential liability for future representation and warranty claims;
- Lock in their return on investment;
- Cleanly exit a business or industry;
- Eliminate the need for purchase price escrows or holdbacks;
- Retain, use or distribute all or most of the sale proceeds;
- Protect passive sellers; or
- Expedite a sale.
Buyers can use RWI to:
- Ensure a source of recovery for the seller’s breach of representations and warranties;
- Ease concerns created by a sellers’ poor financial condition or other practical considerations that can make it difficult to collect from the seller in the event of a breach, such as sellers that are numerous, geographically dispersed or difficult to locate;
- Distinguish its bid and appear more attractive to a seller;
- Provide additional time to detect and report problems by extending the duration of a seller’s representations and warranties; or
- Protect relationships with sellers who may continue working with buyer after the sale as a key employee or business partner.
Unlike standard general liability and property insurance policies, RWI coverages and exclusions can be relatively complex and can also vary depending on the specific policy form and insurance company. You should consult a reputable insurance agent with experience handling RWI applications and policies.
Please contact us if you would like more information about obtaining Representations and Warranties Insurance coverage.
Additional information is also available in our weekly Risk Management Newsletters.