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Client Alert – Representation and Warranty Insurance Protections in the “New Normal” as a Result of Covid 19.

Jun 11, 2020
  • FisherBroyles News

The use of Representation and Warranty insurance (“R&W”) has steadily increased since 2015.  With the expected increase in mergers and acquisitions (“M&A”) due to the COVID-19 economic shutdown, it is likely that purchasers of companies, especially those interested in  distressed assets, will increasingly use R&W to protect and support seller’s representations and warranties typically provided in definitive agreements.

Simply put, the primary purpose of R&W insurance is to transfer to a third-party insurer the risks associated with a seller’s breach of warranty or liability under an indemnity in an acquisition agreement. The risk transfer may be purchased through a commercial insurance carrier or through a private insurance carrier such as a captive insurance company.

The use of R&W insurance has expanded to many sectors (among them healthcare, life sciences, oil and gas, real estate, and financial services). While the use of R&W insurance historically focused on the private equity market (with corporates less inclined to use the product), that is no longer the case. Corporate buyers now understand that seeking to execute a transaction without R&W insurance puts one at a strategic disadvantage, particularly in the auction context.

R&W insurance also alleviates the frustrations with delays associated with the opening of escrow bank accounts. R&W insurance may obviate the need for escrow holdbacks of the purchase price to provide for potential warranty claims. This is a valuable solution to an increasingly common problem that further increases demand for the product.

A significant potential claim that may arise relates to known and unknown tax risks, especially for multinational companies operating in a number of jurisdictions. Financial statements and tax provisions remain the most commonly breached warranties, with employment warranty breaches becoming more prevalent. To supplement R&W insurance, which may cover unknown tax risks, a separate Tax Liability Policy may be obtained for known tax risks discovered during due diligence. In addition to identifying a payor in the event of a breach, the tax liability policy may be used to manage tax risks and minimize tax reserves.  The coverage would include the estimated tax liability, interest, penalties, and defense costs (with a cushion as determined by the insurance carrier). The term of the policy would match the limitation period of the matters insured.

Prior to an M&A transaction, the parties should consider use of the R&W insurance, including tax liability coverage. Our M&A, Tax and Alternative Risk Transfer Groups stand ready to assist in such analysis.

 

For additional information, please contact any of the following: Stuart Anolik at stuart.anolik@fisherbroyles.com, Gal N. Kaufman at gal.kaufman@fisherbroyles.com with any questions or more specific situations.

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These materials have been prepared for informational purposes only, are not legal advice, and under rules applicable to the professional conduct of attorneys in various jurisdictions may be considered advertising materials. This information is not intended to create an attorney-client or similar relationship. Whether you need legal services and which lawyer you select are important decisions that should not be based on these materials alone.

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