Representation and Warranty Insurance
Warranty and Representation Insurance is used during mergers and acquisitions to cover against damages and injuries caused by the seller’s breach of warranty or misleading representation.
In almost every contract, each side makes a series of representations and warrantees to the other side. These are the basis for the transaction, and when one side finds out that the representations and warrantees are not as they expected, there is a chance for a lawsuit.
For example, a Big Company might acquire a Small Company. As part of the transaction, the Small Company may make a representation that there are no outstanding lawsuits against it. After the acquisition, the Big Company might find out that there was a small lawsuit that was lingering but the CEO of the Small Company had forgotten about it. Resolving that lawsuit is an additional expense to the Big Company, and that expense would be covered by the Representations and Warranties insurance policy.
Who buys Reps and Warrantees Insurance?
Policies may be purchased by the buyer, the seller, or both sides, and most policies purchased by the buyer provide coverage for the seller. Representation and Warranty Insurance protects the buyer by protecting the underlying assumptions of a contract. When a merger or acquisition gets done, there are countless things that each side relies upon during the transaction. Reps and Warranties insurance ensures that you will not find something fishy after the deal is done.
How to buy Representations and Warranties Insurance
The process of purchasing a policy begins with the buyer or seller contacting an insurance broker to receive quotes from insurers. An insurance application must be completed, then the underwriters will issue a firm quote. After payment, the policy will be issued.
The following are the main records and details that the insurer may want to review:
- The individuals involved
- The type and extent of the seller’s representations and warranties, as well as the structure of the acquisition agreement
- The seller’s virtual data room
- Due diligence reports on the seller are provided by the buyer.
- The seller’s Disclosure Schedule, which is linked to the purchase agreement
After the insurer has completed its due diligence, the insured may discuss the policy’s precise conditions, such as the extent of losses covered and excluded from coverage.
The Benefits of Representations and Warranties Insurance
The following are the benefits of Representation and Warranty Insurance for the seller:
- Liability protection – If an unexpected complication arises, such as a breach of warranty, R&W Insurance will cover the costs of protection and settlement.
- Clean Exit – Sellers will collect the proceeds of a sale directly after the transaction is completed and avoid dealing with any contingent post-closing obligations by removing escrow or holdback.
- Passive seller protection – R&W Insurance can cover any minority or passive investor who was not in full control of the company but may be liable under joint and several liability.
The following are the benefits of Representation and Warranty Insurance for the buyer:
- Since the buyer can depend on the insurance for indemnity cover, a buyer’s offer will seem far more appealing to a seller if no (or limited) escrow or holdback is needed.
- It can improve or increase the buyer’s level of security in amounts greater than the seller would otherwise consent to.
- Since the seller is more likely to have more detailed representations and guarantees in the acquisition agreement, the buyer’s chances of winning on a claim under the policy increase.
What causes Representation and Warranty Insurance to be triggered?
Typical triggers for representation and warranty insurance can include:
- Contractual issues with customers
- Concerns over work contracts
- Incorrect or incomplete details about a product’s “hidden formula”
- Pending litigation that has not been revealed
- Unpaid bills in the thousands
How much does Representation and Warranty Insurance cost?
Policies for Representation and Warranty Insurance typically include a deductible or self-insured retention. Although the amount varies depending on the risk of the transaction, it is typically between 1% and 3% of the total transaction price.
The premium is determined by the insurer’s risk assessment, liability cap, duration of coverage, and deductible or retention amount. Most insurance providers charge between 1.5 and 3.5 percent of the coverage cap, and the premium is normally a one-time payment made for the lifetime of the policy.
If the policy’s coverage cap is $20 million, the cost would be between $300,000 and $700,000. Premiums are usually set at a minimum of $150,000. The policy coverage of most policies is usually 10% of the overall purchase price.
R&W Insurance is normally not covered in other policies.
Reps and warrantees insurance is normally not covered under general liability, product liability, or other types of business policies. R&W insurance is typically a specialty, surplus lines policy that is written as a one-off policy for a specific transaction. Because this is such a specialty product, your insurance broker will typically use a wholesale broker who specializes in these types of policies.