Historically, the sale of a private company carried with it a significant risk of claims by the purchaser. Months or even years after the sale closed, purchasers would frequently contend that the seller’s representations and warranties in the purchase agreement had been breached. This claim would support demands by the purchaser for the seller to forfeit some or all of the purchase price held back in escrow, and give rise to other claims, as well. The often contentious relationship that existed between company buyers and sellers began to change, however, when representation and warranty insurance (“R&W Insurance”) emerged and began to gain acceptance.
Although it was almost unheard of ten years ago, R&W Insurance is now widely used in today’s seller-friendly merger and acquisition (“M&A”) market. This post therefore provides an overview of R&W Insurance, explains how R&W Insurance works, and reviews how this type of policy allows buyers and sellers to an M&A transaction to allocate risk for their mutual benefit.
Role of R&W Insurance
At its most basic level in this context, R&W Insurance is an insurance policy issued to the buyer of a private company, and it protects the buyer from unanticipated losses that result from a breach of the seller’s representations and/or warranties in the purchase agreement. Some R&W policies are issued to company sellers, but more often the buyer is the insured party.
The concept of R&W Insurance is not new, but it has gained a much broader market acceptance over the past decade due to a number of factors, including, seller-friendly market conditions and an increase in the number of new insurers entering the market. The existence of multiple insurers providing R&W Insurance has led to lower costs (premiums), better policy terms, and a quicker underwriting process allowing the policies to be issued more promptly.