IVCA Feature: Luncheon Highlights of ‘Representations and Warranties Insurance: A High-Level Summary and Market Update’

The topic of Representations and Warranties (R & W) Insurance, as a back end assurance for both buyers and sellers in transactions, was in the spotlight at the first IVCA luncheon of 2015 which took place on March 10, 2015. Sponsored by the international law firm Greenberg Traurig, LLP, the luncheon featured a comprehensive presentation and discussion by panelists:

  • Gary R. Silverman, Moderator – Shareholder in Greenberg Traurig’s Corporate & Securities Practice in the firm's Chicago office.
  •  Peter H. Lieberman, Panelist – Co-Chair of Greenberg Traurig’s Corporate & Securities Practice, Chicago office.
  • Aaron T. Slavens, Panelist – Shareholder in Greenberg Traurig’s Corporate & Securities Practice in the firm's Miami office.
  • Jeffrey Anderson, Panelist - Senior Vice President and Southeast Branch Manager of North American Mergers and Acquisitions at Allied World.

The power point presentation broke down the R & W insurance product into easier-to-digest topics, and the panelists added additional commentary for each slide.


SLIDE ONE: Types of Representations and Warranties Insurance

Distinguishing between the Sell-Side Policy and the Buy-Side Policy.

Peter Lieberman: Representations and Warranties Insurance is a policy that protects the buyer or the seller – or both parties in many cases – from any breach in representations or warranties in any transaction. For the sell-side policy, it provides coverage to the seller of a business for indemnification claims that the seller breached in any of its reps and warranties. On the buy side of the policy, it protects the buyers for losses resulting from a breach of any of the seller’s reps and warranties. It basically takes the risk out of any breach, it makes a deal go much smoother, and allows for better negotiations.

Jeffrey Anderson: One difference. Sell-side is a typical third party liability policy, which protects them against liabilities coming in. Buyer’s side is a first party policy, like ‘my house burned down, so you pay me.’ It’s different than a third party policy.

Gary Silverman: Is the pricing different between sell-side policy, and a buy side policy?

Anderson: No, it’s fairly similar.


SLIDE TWO: How to obtain coverage

Commentary on the three ways of obtaining coverage, through a direct insurer/underwriter, through a broker, or through negotiations of attorneys.

Lieberman: Usually when you’re in a deal, and you want a policy, your broker will solicit bids from the underwriter.


SLIDE THREE: Reasons for purchasing coverage

Both on the seller and buyer side.

Lieberman: As a seller, it’s a great thing. They pay some money for a third party, and I can walk away from the deal without somebody coming back to me with a claim for a breach. That is the most important aspect. You pay a premium and you’re done. And, as I said earlier, it simplifies the negotiations. As a seller, you’re typically fighting in negotiations on limiting the scope of reps and warranties. Sellers can also go out for a specific deal, put it out for auction, but have as part of the potential offer a staple policy.

Silverman: What about the buyer’s side?

Lieberman: Same type of calculus from the buyer’s perspective. They are indifferent if they have a claim against the seller, whether the seller takes care of it or a third party does. If you’re using a policy as a buyer you do have a strategic advantage, especially in a walk away transaction. As a buyer, in heavy negotiation indemnification provisions, there might be a advantage for terms with a policy. Insurers are also incentivized to act appropriately in addressing claims, because their sales for those policies would dry up if it got out that they weren’t doing so.


SLIDE FOUR: Market trends

Since the policy product has been on the market awhile, how and why has it come into the mainstream.

Anderson: Here are the stats. In 2014, we think there were 600 deals underwritten, which is up from 400 in 2013. It’s growing, because basically there are more converts, because it’s a successful product. By the end of last year, it was close to a 100 a month. It’s been interesting to see that when a seller puts their business out there, all the buyers go out and get policies. 90% of the deals last year were on the buy side.

With Venture Capital, it’s more on the sell side. but Private Equity is driving this product. That’s a phenomenon we see continuing.

QUESTION: What is the breakdown between Private Equity and Venture Capital of the 90% of buyer side policies?

Anderson: Very little VC. There is a little bit of activity, on the West Coast. With some real world examples, you would have an angel investor on the sell side, who wants a clean and crisp exit. Basically when negotiating an exit, it’s about getting the money. And once the word gets out that one person gets it, we end up selling it to the other investors in the exit. It’s bundled, and managed by a company that’s a shareholder representative.

QUESTION: What percentage of deals do you approve, and how has that changed over time?

Anderson: It’s gotten tighter at the latter part of 2014, because it had to, and we could only afford to look at the most pristine deals. The law firms matter on both sides. We see a mismatch, it’s not a good deal for us. But as a matter of supply and demand, it has loosened in 2015. It’s bouncing around right now, but as you see more markets come in, it gets a bit broader.

Silverman: Does pricing improve, as the markets improve?

Anderson: People ask me what has changed in the last five years. it’s pricing and the efficiency and streamlining of the underwriting process. The norm for pricing has remained stable, 3-4% of the coverage limit.

Lieberman: For example, if you have a 100 million dollar deal, you’d probably be covering 10 million, which would be a one time 3-4% premium of that amount, not on the whole deal.

Anderson: And coverage is available for ‘known’ issues. There are breaches that are known, and those unknown. Our discussion here is for the known issues, such as tax or environmental possibilities.


SLIDE FIVE: Underwriting Process

Anderson: It’s all about comfort with the target – within the draft definitive agreement, financials and management backgrounds. We need to understand where the legacy issues might fall. On the sell side, you need to have audited financials. It’s about financial statements, and no undisclosed liability breaches. We’re very mindful of that, and we want an auditor to go deep into the books – with management letters, for example – to flow through on deals.

Aaron Slavens: What about the selection of underwriters?

Anderson: That’s stage two. You get some non-binding terms from us. If you agree to those terms, we have you sign an expense letter. If, for example, Greenberg Traurig does some work for me, then a fee would be paid in addition to the premium. That diligence fee is non-refundable. I’ve done deals in two days, but we generally like to have 1-3 weeks.

Policies are highly negotiable. Their lawyers chime in, my lawyers chime in, but hopefully it is just around the edges, and not anything too substantive. Exclusions are part of it, and they are painful...you have to pay attention to them.

Slavens: One of the things we try to do is push back to the policy buyer, and point out things we would have done in their position, and push it back for them to actually do, and that give us comfort that they’ve answered our questions. That’s how we avoid exclusions.

Lieberman: In this context, it’s not possible for the underwriter or their lawyers to re-do a deal. What they’re doing is ‘diligencing the diligence.’ We’re asking, within the process of deal, has that diligence been done effectively? If you can’t give a proper answer on a particular issue that an underwriter comes up with, lo and behold it ends up as an exclusion. It’s about insuring the ‘known’ risks. That’s why the give-and-take is important.

Anderson: We do require that someone on the deal team, on behalf of the deal team, signs in that they do not have any actual knowledge of a a breach. We’ll get a push back on it, but the legal team does a good job of explaining that it’s necessary, or those ‘unknowns’ could blow the whole thing up.


SLIDE SIX: Key Terms

Slavens: There are differences between the sell-side and buy-side policies. On the sell side, your policy matches basically what has been negotiated. On the buy side, there is more flexibility for terms that don’t necessarily match what the purchase agreement has.  It’s more negotiable. That definition of what is ‘known’ can be negotiated.

The retention – basically a deductible – is typically 1.5 to 2.5 percent of the overall purchase price, and can drop to one percent 12 to 18 months after closing.

Anderson: Think of a premium as a percentage of the limits employed, and retention is a percentage of the purchase price. The policy is about the bigger stuff in the buyer and seller negotiation.

Silverman: The more you pay for the policy, the smaller retention you have.

Slavens: One other term is the length of survival of the warranties and reps. It’s typically six years, and you can get better coverage for a longer time. Also the minimum policy premium, given the size of deals and the business of the insurers, is typically 150,000 dollars and up.

Anderson: The reasons these policies have taken off is that they’re able to sync up with both pricing and the overall agreements much more.

Slavens: We’re also seeing the seller taking on some post-closing exposure, which is typically negotiated, and covering some portion – .5 to 1 percent – of the retention.

Anderson: What we’ve found, if that you’re sitting on the buy side, and we’ve attached a bigger retention, the buyer has more incentive in that negotiation – that also keeps them pressing the seller, and keeping them open on terms.


FINAL SLIDE: Standard Exclusions

Slavens: There are standard exclusions – including known liabilities plus breaches; civil & criminal fines; punitive damages; pension underfunding; environmental issues such as asbestos; fraud by the insured’s deal team; and breaches that occur between the signing of the purchase agreement and the closing of the transaction, but coverage may be had for that.

Silverman: We’ve run across some things between signing and closing on the buying side. For example, the buyer doesn’t know something at signing and it moves forward to closing. Do you buy coverage for that? Do you put the seller on the hook? Then the seller suddenly has interest in the reps and warranties, more so then when they thought they were off the hook. The longer the period between signing and closing, the more potential there is for something to happen.

Lieberman: You can bind the policy at signing, you are then theoretically covered, but not for everything, like a lawsuit that comes up. Standard exclusions, which are not excluded in a rep and warranty deal, we can do that in a walk away deal, and then bring up the exclusions. These are normally things that are covered from the seller. There are places where the policy doesn’t line up perfectly, but if you talk to most funds, they don’t make any claims, but a time period afterward is peace of mind.



QUESTION: How does a policy handle an IP (internet Protocol) carve-out in a tech deal?

Slavens: The policy has the limits that it has, and if the IP has a higher limit, it won’t go over that. But there is add-on coverage, and you can stack it on. The cost of the coverage can be well worth it in certain deals.

Anderson: It can moderate as the chance of loss moderates. Depending on who the players are, we can moderate from there.

Slavens: The agreement and the policy can be separate. You can have certain coverage in the agreement, and the policy can provide different coverage.

QUESTION: Can a seller be liable for a product recall issue down the line, after the closing?

Anderson: The first thing we’re taught in law school is to say, ‘it depends,’ and that is the answer here. It’s a case by case basis. If that company has a recall policy in place, and a clean history, I can see the underwriter sitting above it, and then it takes good legal negotiations to make sure you have continuity, in case it does come up.

The next IVCA Luncheon – topic to be determined – is scheduled for April 21st, 2015.