Representations and Warranties Insurance
Representations and warranties insurance (also referred to as reps and warranties insurance, RWI, R&W insurance, warranty and indemnity insurance, or W&I insurance) is designed specifically to cover losses resulting from unknown breaches for all of a seller’s representations and warranties in a private acquisition agreement.
Although R&W insurance can be used in a variety of scenarios, it is used primarily to achieve one of three main objectives:
- To supplement a buyer’s existing indemnification limits (i.e., indemnity cap, survival periods, etc.)
To provide coverage to a buyer in lieu of traditional indemnification limits, essentially replacing a buyer’s remedy for breaches related to representations and warranties under the purchase agreement
As a means of backstopping a seller’s existing escrow/indemnification obligation to the buyer
R&W insurance will generally cover the breaches of all general and fundamental representations and warranties within a purchase agreement (e.g., misstated financials, unknown third-party claims over intellectual property, failure to obtain environmental permits, etc.), which are unknown to the buyer’s deal team at the time of execution of the agreement. Additionally, pre-closing tax indemnities are generally covered, but only to the extent the seller’s financials were incorrectly calculated, not for failure to collect from seller.
Additionally, a typical buy-side policy does provide the buyer with the benefit of coverage for seller fraud. For more, see What is Representations and Warranties Insurance? — Scope of Coverage.
- Eliminate or reduce escrows and holdbacks
- Eliminate or reduce indemnification risk and associated tail liability
- Avoid cost and hassle of dealing with claims, disputes, etc.
- Distribute capital early to investors and/or close end-of-life fund
- Protect passive sellers not in control of operating company (e.g. several and joint liability protection)
- Abbreviate transaction negotiations to achieve a quicker exit
- Box in looming liabilities to close a transaction
- Enhance bids by eliminating or reducing sellers indemnity package (limits, escrows, holdbacks, etc.)
- Extend survival, limits and other indemnity coverage terms concurrent with standard market policy terms
- Eliminate/reduce complexities of claims made against rollover equity and management
- Avoid risk of collecting from multiple seller teams and investors
- Abbreviate transaction negotiations
Tax indemnity and tax credit insurance
Tax Indemnity insurance provides coverage for an unintentional error and subsequent challenge by the IRS or state, local or foreign taxing authority. These policies can be used to cover the tax treatment of a tax-free reorg., tax-free spin-off, S-Corp status, REIT qualification, NOL carryforward, and transfer pricing position. As the Private Letter Ruling (PLR) from the IRS has become harder to receive, Tax Indemnity policies have become more sought after as an alternative risk management tool to hedge against a potential adverse ruling by IRS.
Tax Equity Credit insurance protects investors against the recapture of credits should the qualifications for receiving those tax credits based on, ‘placed in service dates’, or other investment criteria, be subsequently challenged. Tax equity credit projects for renewable energy, local investment and production, low-income housing and historic rehabilitation have all been insured over the past couple of years.
- Streamlined execution of transaction agreements by bringing buyer and seller together
- Covers tax, interest, penalties, gross-ups and contest costs (‘change in law’ is often covered)
- Covers U.S., state, local and/or foreign tax authorities
- Can be used as an alternative to a tax opinion
Contingent liability, litigation buy-out, and other risks
Other risks for known issues can arise in an M&A scenario and potentially stop a deal in its tracks. To the extent solid supporting documentation and evaluation of a specific risk exposure exists, along with appropriate valuations, the M&A insurance markets will potentially underwrite these liabilities. By transferring these risks to a third-party insurer, the buyer and seller can get past differences in opinions on severity and likelihood of a potential risk, and focus on completing the remainder of the transaction.