randwInsurance to protect against breaches of the representations and warranties provisions of mergers and acquisitions purchase agreements is an increasingly important part of many M&A transactions. Among other things, reps and warranties insurance can help facilitate the transaction by reducing the amount of the purchase price that must be set aside to provide the buyer with indemnification protection against breaches of the representations and warranties. As detailed in a March 2, 2016 Law 360 article entitled “A Buyer’s Guide to Reps and Warranties Insurance” (here, subscription required) by Wayne Bradley and Jonathan Picard of the Dentons law firm, there are certain situations in which representations and warranties insurance may be particularly appropriate.  And as detailed in a recent study from a leading insurer, claims activity suggests that a significant number of transaction do run into trouble after the deal has closed, underscoring the need for this type of insurance.


As the law firm memo’s authors point out in their article, reps and warranties insurance is best suited for transactions valued at $20 million or greater, as participants in the transaction may find the insurance premium for transactions smaller than that to be cost-prohibitive. Although reps and warranties insurance is available for both buyers and sellers, most policies are purchased by buyers.


There are a number of M&A situations in which buyers may particularly want to consider Reps and Warranties insurance, as the authors detail. First, in an auction situation, buyers looking to make their bid “more appealing” by offering to obtain reps and warranties insurance, as the inclusion of the insurance as part of the bid would offer to reduce the sellers’ risk and allow the sellers to take more money “off the table” at closing.


Second, even in a noncompetitive setting, buyers can try to negotiate a lower purchase price by offering to purchase reps and warranties insurance, which would reduce the seller’s risk in the transaction.


Third, when the buyers and sellers are having difficult agreeing on key terms – such as the terms of the indemnity, the amount and terms of the escrow, or the survival period of each representation or warranty – the insurance may help facilitate the completion of the deal, by shifting part of the risk to the insurer, allowing the parties to overcome roadblocks to deal completion.


Fourth, when the sellers will continue to manage the target company after the transaction, representations and warranties insurance can help avoid potentially distracting conflicts that might arise in connection with indemnification claims for breaches of the representations and warranties.


Finally, there may be situations – such as, for example, when the seller is financially distressed – when the seller may lack sufficient funds to pay indemnities. Also, after the transactions closes, some sellers may be difficult to locate or to collect from. Representations and warranties insurance substantially increases the likelihood that the buyer seeking indemnification will be able to collect.


The chances of these kinds of indemnification claims arising is not a mere remote possibility. According to a recent study by the insurer AIG entitled “What Happens After the Deal Closes?: Representations and Warranties Insurance Global Claims Study” (here) the insurer’s claims data “provides strong evidence that a significant number of transactions do run into problems after the deal has closed.” The report states that in connection with about one in every seven of policies that the insurer has issued globally a claim is reported.


Interestingly, transactions in Asia Pacific have the highest claim frequency (18%), while the Europe, Middle East, and Africa region (EMEA), which has the lowest frequency (11%) has the majority of the largest losses. The probability of a claim varies by deal size, with deals at either end of the spectrum being somewhat riskier than those in the middle – that is, frequency is greatest for transactions under $100 million (15%) and over $1 billion (19%).


If there is going to be trouble, it is likeliest to emerge shortly after the deal is completed. According to the claims study, more than half of the claims arose within the first year after closing, and 74% were filed within the first 18 months. However, that does also mean that 26% of claims were reported 18 months or more after the transaction closed. While sellers purchased only about a quarter of all Reps and Warranties policies, they are more likely to report a claim (19% vs. 13% for buyers). However, buyers have been more likely to have a large loss, as the majority of the top 15 claims have involved buyer-side policies.


The most commonly alleged breaches were reported for financial statements, tax information, and contracts. The U.S. has a more diversified range of reported breaches, as the U.S. claims unlike those from other regions involved alleged breaches in the areas of intellectual property, data, and insurance.


A Break in the Action: I will be traveling over the next few days, and so there will be a short break in The D&O Diary’s publication schedule. Regular publication will resume the week of March 14, 2016.