As 2024 dawns, the landscape of acquisition and divestiture deals is poised for a significant shift, with Representations and Warranties Insurance (RWI) set to play a more pivotal role than ever before.
This evolution marks a crucial turning point in how parties navigate the complexities of mergers and acquisitions (M&A), offering a sophisticated mechanism to transfer risks and minimize liabilities. RWI not only reshapes the negotiation dynamics between buyers and sellers but also introduces a nuanced layer of security and assurance in transactions that could otherwise be fraught with financial uncertainties and legal hurdles.
This article delves into the essence of RWI, exploring its increasing prevalence in M&A agreements, the tangible benefits it brings to the negotiating table, and its limitations. As we unpack the multifaceted nature of RWI, we invite you to consider whether this evolving insurance product aligns with your strategic goals in the ever-changing realm of corporate transactions.
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In a buy-side representations and warranties insurance (RWI) policy during an M&A deal, the buyer is insured against losses from any breaches of the seller’s promises in the acquisition agreement.
This approach transfers the risk from the seller to an insurer, reducing or removing the seller’s responsibility for breaches. This setup allows both buyer and seller to proceed with limited liability without significantly affecting the buyer’s protection.
Consider a scenario involving the sale of assets or even an entire asset portfolio in a specific market, where the seller either exits the market or has dubious creditworthiness. A key area of negotiation often centers on the extent of post-closing recourse available to the buyer and the provision of security (such as indemnity escrow or a holdback of part of the purchase price) to cover financial losses arising from the seller’s failure to uphold its promises and guarantees.
For instance, imagine a buyer acquiring a company’s assets in the renewable energy sector, only to discover post-purchase that the environmental compliance representations needed to be more accurate, risking significant fines. In such cases, the discussions before closing would have heavily focused on ensuring the buyer has financial protection against this scenario, either through a pre-agreed escrow fund or a portion of the purchase price being withheld until all representations and warranties are verified as accurate.
Bloomberg Law states that there has been an upward trend in the proportion of publicly filed M&A agreements that include references to RWI over the past ten years. This increase is marked by periods of relatively modest increases and instances of more significant jumps in the proportion of M&A agreements that include RWI provisions before the decrease from 2021 to 2022.
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Harvard Law School states using RWI to limit or eliminate the seller’s liability for rep breaches benefits both parties and may make the seller more willing to expand the substantive coverage of its reps and reduce the use of knowledge qualifiers.
RWI can distinguish the buyer’s bid in an auction process by providing a more attractive economic bid and shortening negotiations over the acquisition agreement.
There are upsides and downsides to using RWI for your M&A agreement. Richards Rodriguez & Skeith offer unique insight into corporate and securities law. If you are considering this route or want to know if it is a good option for your M&A, contact us today so we can navigate your options together.
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