Representations and warranties insurance (“R&W insurance”) has become a popular tool used in effecting private equity (“PE”) transactions. R&W insurance serves to shift responsibility for most seller representations and warranties to a third-party insurance underwriter. This can serve to bridge negotiation gaps while providing benefits to both buyers and sellers. R&W insurance brings with it, however, certain drawbacks that should be taken into account. This two-part article highlights key pros and cons of R&W insurance (as well as mitigants for certain of the cons), first from a buyer’s perspective and then from a seller’s viewpoint.
Pros: The key advantage of R&W insurance to sellers is limiting (or eliminating) their post-closing liability for breaches of reps and warranties made in the acquisition agreement. This advantage is particularly valuable to PE sellers, including funds nearing the end of their lifecycle that wish to disburse deal proceeds to limited partners and liquidate. Absent fraud, R&W insurance can provide sellers with certainty as to the proceeds a seller will receive in a transaction.
Cons / Limitations:
- Some buyers (particularly strategic ones) are not willing to use R&W insurance;
- Buyers may seek special indemnities or other protections from seller for coverage gaps under the R&W insurance; and
- As insurers will typically not begin underwriting until a bidder has formal or de facto exclusivity, R&W insurance typically adds additional time to the sale process following selection of the bidder (though this area remains under development).