Representations and Warranties Insurance
Mergers and Acquisitions. The headlines are full of them. A recent check of the Financial Post online showed close to 30 articles about active business Mergers and Acquisitions…and that was just on the first page of over 60 pages. The M&A process has been described as a “minefield” and Canadian law firms which specialize in this area are doing well – very well. Enlisting a well-seasoned M&A legal team is key in helping you successfully close a multi-million dollar, multi-level transaction but there’s an important insurance aspect that you need to know. It’s an insurance coverage which helps make a business more attractive to purchasers and also protects sellers from potential legal action long after both sides shake hands.
Why Buy It?
The Representations and Warranties clause found in a typical Merger and Acquisition contract is the most litigious aspect of this type of transaction. Most future lawsuits hinge on the Representations (those things stated in the contract about the current state of the business in question) and Warranties (the assurances that the things stated about the current state of the business are in fact true). Representations and Warranties Insurance protects both the buyer and seller from unknown and unintended contract breaches. This results in a huge benefit for both sides. The insurance policy pricing structure makes it most attractive for M&A’s valued between $25M and $1B. We’ll explore the unique benefits to the Buyer in Part 2 of this series and to the Seller in Part 3.
After a slow start, the Canadian demand for R&W insurance has taken off and this has led to competition between insurers. Premiums have dropped recently but a general rule of thumb still applies. Most insurers charge 2-4% of the value of the transaction’s indemnity exposure in order to come up with the policy’s premium. The transaction’s indemnity exposure becomes the insurance policy limit for Seller’s Side policies whereas Buyer’s Side policy limits are determined in part by the buyer’s risk appetite. Insurers calculate the retention by charging 1-2% of the total value of the transaction. Insurers usually charge a minimum premium of around $150,000 and will charge an additional $20,000 – $40,000 “underwriting fee” to provide a formal quote. The costs are fitting because each policy is unique to the transaction and the insurers usually hire third-party consul to assist the formal underwriting process. Generally, policy terms match the survival of the underlying agreement up to six years. Global insurer, AIG, recently published their R&W claims trends report and it shows that about 20% of their Representations and Warranties policies are being triggered by a claim.
What’s the Process?
It will take a couple of weeks to secure a formal R&W insurance quote and the first step is to consult with your legal advisor and then an insurance broker who’s familiar with R&W coverage. The broker will need a copy of the transaction documents and the latest financials. Armed with this information, the broker will then approach the marketplace and begin negotiating coverage and price. The underwriter will create a “Non-Binding Indication Letter” (NBIL) which details coverages offered, coverage exclusions, premium charged along with policy and retention limits. This service is free of charge and should give you enough information to determine if you want to pursue a formal quote. If you proceed, the chosen insurer will require a non-returnable “underwriting fee” described earlier. The formal quote should arrive in 5-10 days and then a follow-up call between the insurer and insured’s consul to discuss the terms is set. If all is agreed upon, the policy can then be bound.