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Understanding Reps and Warranties Insurance in Business Transactions

Lee Henry

When buying or selling a business, one key component of the deal is the representations and warranties (reps and warranties) made by the seller. These are assurances provided by the seller about the state of the business, covering everything from financial statements to compliance with laws. If these representations turn out to be false, the buyer may suffer financial losses, and disputes can arise. This is where Reps and Warranties Insurance (RWI) steps in, offering a safety net for both buyers and sellers.


What is Reps and Warranties Insurance?


Reps and Warranties Insurance is a specialized policy that provides coverage for financial losses resulting from breaches of the seller’s representations and warranties in a business transaction. It serves as a risk management tool, enabling parties to mitigate the financial and legal exposure that can occur when a breach is discovered after closing.


Key Benefits of RWI

  1. Risk Mitigation: Protects buyers from unforeseen liabilities and sellers from post-closing indemnification claims.

  2. Facilitates Negotiations: Reduces tension between buyers and sellers by transferring potential risks to the insurer.

  3. Enhances Deal Speed: Helps streamline negotiations by minimizing disputes over indemnification terms.

  4. Improves Seller’s Position: Enables sellers to walk away with more of the purchase price without setting aside large escrow funds or indemnity reserves.


Who Pays for RWI?


The responsibility for paying the RWI premium depends on the terms of the transaction and the negotiation between the buyer and seller. In general:


  • Buyer’s Policy: In most cases, the buyer purchases the policy to protect themselves against breaches of the seller’s representations and warranties.

  • Seller’s Contribution: Sellers may agree to pay a portion of the premium as part of the deal terms, especially in competitive transactions where buyers demand the coverage.

  • Shared Cost: Some transactions involve splitting the cost of the policy between the buyer and seller.


The premium cost is typically a percentage of the policy’s coverage limit, ranging from 2% to 4%, along with an underwriting fee and potential deductibles.


What Does RWI Cover?


RWI generally covers financial losses resulting from breaches of reps and warranties outlined in the purchase agreement. Common covered areas include:


  • Inaccuracies in financial statements

  • Undisclosed liabilities

  • Tax issues

  • Ownership of assets

  • Intellectual property disputes


What Is Not Covered?


While RWI provides broad protection, it excludes certain risks, such as:


  • Known issues identified during due diligence

  • Forward-looking statements

  • Breaches of covenants

  • Purchase price adjustments

  • Certain environmental liabilities (depending on the policy)


When Is RWI Most Useful?


Reps and Warranties Insurance is particularly valuable in:


  • M&A Transactions: Especially for private equity deals or competitive sales processes.

  • Cross-Border Deals: Where legal and regulatory complexities increase the risk of breaches.

  • Distressed Sales: To reassure buyers when acquiring a business in financial trouble.

  • Competitive Auctions: To make the seller’s offer more attractive to potential buyers.


Conclusion


Reps and Warranties Insurance is a powerful tool that can help smooth the path to closing a deal by transferring certain risks to an insurer. Whether you are a buyer seeking peace of mind or a seller aiming to maximize your proceeds, RWI can be tailored to fit your transaction’s unique needs. By addressing potential post-closing liabilities upfront, this type of insurance provides clarity, confidence, and security for all parties involved in a business transaction.

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