paperstackRepresentations and warranties insurance has been around for years, but it is becoming an increasingly important part of M&A transactions, according to an August 24, 2015 Law 360 article (here). According to the article, more buyers are “embracing representations and warranties insurance” in order to “stand out in crowded auctions,” particularly where the seller is a private equity firm. The insurance product is “increasingly deemed a prerequisite toward sealing middle-market deals.”


As I have detailed in prior posts (for example, here), reps and warranties policies can preserve deal value by shifting potential liability for breaches of transaction representations and warranties discovered after deal closing. In exchange for an upfront payment, the policy may reduce or eliminate the need for seller escrows or holdbacks for contingent liabilities – an arrangement that could be particularly attractive in the current low interest rate environment. Although the policies are available either for the buyer or the seller, most policies are buyer-side policies.


According to one commentator quoted in the Law 360 article, a few years ago, the reps and warranties insurance product provided “a way for you to distinguish your bid,” whereas today, “in a competitive middle-market auction where the seller is a financial sponsor, if you don’t use this product, you’ll be at a competitive disadvantage.”


One of the reasons for the greater take up and relevance of the product is, according to the article, that policies have become more standardized and premiums have fallen, while M&A activity has widened the pool of insurable transactions. Buyers are also “more inclined to embrace the tool as it gains credibility” and as it has overcome “initial skepticism over whether claims would actually pay out.” Over time, the carriers have developed a claims “track record” that now supports sales and underscores the value of the product. The appeal to buyers is that if a claim does arise, they can pursue it directly from the insurer instead of suing a private equity firm.


The increased uptake of the product has also helped sellers, who otherwise would have to set aside a portion of the deal proceeds as escrow to satisfy indemnification obligations for breaches of representations. Instead of having the funds tied up, the sellers can “now reap full proceeds of deals more quickly while subjecting themselves to less liability.”


The article notes that there are some limits to the growth of the reps and warranties product. Many insurers are unwilling to cover high-risk industries, such as health care providers that are heavily dependent on Medicare or Medicaid reimbursements, or “environmentally sensitive industries that involve controversial procedures like fracking.”


Although not discussed in the Law 360 article, another reason for the increased uptake of the product is that a recurring past concern about the insurance product can now be addressed through policy wording (at least when the product is properly put together). As I noted in prior posts (here and here), there have been recurring questions whether the product would provide appropriate protection for multiple-based damages – for example, where the damages are expressed as a multiple of a negotiated EBITDA. It is now possible in the marketplace for a buyer to obtain a policy allowing the recovery of damages based upon a multiple of earning, but the parties must use care in negotiating the specific insurance terms and waiver of consequential, special, and indirect damage provisions, lost profits and diminution of earnings provisions in the underlying acquisition agreement to obtain the intended deal consequences.


The Word Choice Police Will Have Something to Say about This: So, yesterday I was reading a law firm memo on the Mondaq website. The August 24, 2015 article, by the Dentons (USA) law firm, was entitled “Eighth Circuit Affirms Core Tenant of Claims Made Insurance Coverage” (here). This article title reflects one of the frequently recurring word choice errors, between the work “tenant” (that is, somewhat who pays rent on a lease) and “tenet” (that is, a belief or principle). In the law firm’s defense, in the version of the article on the law firm’s website (here), the article’s title uses the correct word (that is, “tenet,” not “tenant”), so the error appears to have crept into the title when the article was posted on the Mondaq site.


There are a number of word pairs like tenet/tenant that frequently result in word choice errors, as I discussed in a prior post, here. I hope everyone reading this post will now be sure to avoid saying tenant when what it meant is tenet.