Representations and Warranties Insurance (“RWI”) has become a mainstay in acquisitions—and for good reason: it is a powerful risk mitigation tool. Generally speaking, RWI serves as a source of recovery in the event of an unexpected, unintentional breach of a representation or warranty in a purchase agreement. Notably, these policies do not cover breaches of covenants, purchase price adjustments, or forward-looking statements.

RWI first came on the market in the 1990s; as of 2010 there were only a handful of providers. Now, this number has grown to reach upwards of 40 providers. These providers offer two types of products: a buy-side and a sell-side policy. Buy-side RWI provides relief to the buyer and allows them to seek indemnification from an insurer for losses covered by the policy. Again, these would be unexpected, unintentional breaches of representations and warranties.

While far less common than buy-side RWI, sell-side policies are still offered by around half of the RWI provides. Sell-side RWI protects against covered losses when the buyer seeks indemnification from the seller with respect to breaches of their representations and warranties. These policies can be designed to protect all or part of the held-back or escrowed funds, to protect sellers’ clawback risk above such funds, or to cover a combination of all these aspects.

Upside to Obtaining RWI.

Buy-side RWI can eliminate the need for or reduce the amount of holdback or escrow funds. Since RWI gives a seller the ability to walk away, it can make a buyer’s bid more attractive. Moreover, RWI helps to preserve deal relationships and can supplement sellers’ indemnification obligations.

With a sell-side RWI policy, the seller is still liable to the buyer for breaches of the purchase agreement—the policy simply reimburses the seller for those breaches. As such, a sell-side policy typically comes into play in the absence of a buy-side policy. Sell-side RWI adds purchase price certainty insofar as the policy covers indemnification-related losses covered by the policy. In addition, a seller may be willing to move more quickly towards closing if they know they have sell-side RWI to backstop indemnity exposure. Moreover, sell-side RWI can protect passive and minority sellers. This is particularly helpful where minority sellers may not have been involved with company operations or deal negotiations of representations and warranties or indemnification provisions.

The RWI Process, Broken Down.

The typical RWI process can take around 2-3 weeks. At Step 1, the insurance agent submits preliminary underwriting materials to RWI-specific underwriters. These materials typically include the target company’s financial statements, a current draft of the purchase agreement, draft disclosure schedules, confidential information memorandums, and any other management materials.

At Step 2, quotes are reviewed, and negotiation commences. The underwriter will provide a non-binding indication letter showing preliminary insurance terms. This is typically reviewed by the insurance agent.

At Step 3, most underwriters charge a fee to cover the cost of their underwriting counsel. Fees are typically due when the proposed insured zeros in on one quote and selects the insurance carrier’s initial formal underwriter. The insurer and their counsel then conduct an underwriting call with the insured, deal advisors, and insurance agent.

Typical Policy Terms and Exclusions.

Since the product has become more common over the past few years, there is some policy standardization. Nonetheless, terms are still heavily negotiated and very deal-specific. RWI policies typically cover 10-20% of the total enterprise value or purchase price. The premium is typically a percentage of that amount and is split among the parties. The deductible usually correlates to the deal value (often one to two percent) and typically decreases a year after closing.

The policy will in most cases cover unexpected, unknown breaches of representations or warranties. The term is usually three years for general representations and six years for fundamental representations. The underwriter will require a no-claims declaration at closing.

Conclusion.

Given the clear benefits and rapidly increasing availability of RWI, it is no surprise to see its prevalence on the rise. In the transportation space, Scopelitis stands poised to tackle complex diligence inquiries, whether it be at the eleventh hour or—fingers crossed—early in the deal. When the time comes to provide underwriters with a thorough report of the target company’s transportation operations, our Firm’s decades of experience will help your company navigate these complex issues.