Why you should consider this type of M&A insurance

Representations and warranties (R&W) insurance is a type of M&A insurance that’s beneficial in cases where there will be a lasting relationship between a buyer and a seller post-transaction. And it can even increase the likelihood of closing a deal, speakers say during a Dentons podcast.

R&W insurance is a risk mitigation tool that typically allows an insured — the buyer in most transactions — to make a claim under an insurance policy when a covered representation or warranty in the purchase agreement is breached, explains Derek Levinsky, a Toronto-based partner in Dentons’ corporate and insurance group.

“In theory, it’s avoiding the buyer having to seek recovery from the seller under the indemnification provisions…” Levinsky says during episode 1 of Dentons’ M&A podcast. “Ultimately, it’s providing at least that comfort from kind of a seller perspective, that essentially there’s going to be coverage independent of the purchase price proceeds that the seller is receiving…”

R&W insurance can sometimes significantly reduce the indemnification provisions (the covenants, or pre-closing and post-closing agreements). “It can make the negotiation process a little less costly and a little bit more efficient for the parties involved,” Levinsky says.

Adds Riley Dearden, a Dentons partner and Calgary lead of the M&A group, “in a scenario where a seller…has leverage to negotiate very limited indemnification provisions, or where the buyer is worried about its ability to recover from the seller post-closing, that’s when we might want to recommend a buyer look into obtaining rep and warranty insurance on a deal.”

Benefits abound

Reps and warranties insurance replaces or enhances the indemnification provided in the contract itself, says Dearden. This type of insurance can further “extend the survival period of the reps and warranties” so that a buyer has more time to discover breaches after closing.

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“It can also enhance the appeal of potential buyers’ bids in a competitive auction process, and minimize friction between buyers and sellers when you continue to have a relationship post-closing,” he notes. “Additionally, it can increase the likelihood of closing by avoiding protracted and contentious negotiations.”

For sellers, R&W policies are quite attractive when they want to reduce or eliminate their indemnity obligations, Dearden says.

“It can enable a seller to receive a greater portion of the sale proceeds at closing, as typically when you have a policy in place like this, a much smaller amount of [the] purchase price is put into escrow or subject to some sort of post-closing pullback.” (This refers to a portion of the purchase price that is held back after a deal closes to protect the buyer from risks or liabilities post-transaction.)

Podcast moderator Danny Wakeling, an Edmonton-based partner and national co-lead of Denton Canada’s M&A group, asked what’s been the catalyst for more widespread adoption of R&W insurance in Canada, and if there are certain types of transactions for which it’s best suited.

Dearden says the ability for insurers to provide R&W insurance on smaller deals has become more prevalent in Canada, and led to a reduction in retentions and premiums charged. “It’s also being used more frequently on purely domestic transactions where no private equity fund or financial investor is involved, which were historically the main reason why you would see a rep and warranty insurance policy put in place on a deal.

“Historically, it was like the $20 million to $2 billion range,” Dearden says. “While that is still the case, we’re seeing a lot of policies now dip into like the $10 million range, or even the $5 million range.”

Levinsky agrees. “It does make it more efficient and can be attractive for small deals which were once kind of just cost-prohibitive and just wasn’t available for those deals.”

Jason Contant

Jason has been an award-winning journalist with Canadian Underwriter for more than a decade, including the past three years as associate editor and, before that, as digital editor for seven years.