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.
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