Rep Insurance in Acquisitions

A growing practice is for either a buyer or a seller of a company to insure the risk that there is a misstated warranty or representation in the acquisition documentation which triggers an obligation of the seller(s) to compensate the buyer for the damages arising from such misstatement.  This product offering has become more prevalent recently, as it facilitates reaching a deal rather than getting hung up on sorting out liability for unintentional misstatements.

As these policies have become more common, confusion has arisen about how efficacious they are.  This breaks into two inquiries: first, do they pay off or are the mechanics of proving a claim too arcane; second, just what is being insured against.

AIG, a major insurer in this space, has shared some experience about claims payment; seems almost 20% of all policies actually pay off with an average payment of about $4Millon; most claims arise in deals from $100M to $1B.  Most typical payments relate to misstated financials, tax obligations, legal compliance or contents of material contracts.

As to what is covered, that is really incredibly simple: these policies are widely varied and you have to read them carefully.  Law firms often say you need a lawyer to read them, and surely lawfirms can do this work and can pick up some difficult areas.  But there is no reason why any businesspeople cannot read the coverages and exclusions for themselves. For example,  all exclude active fraud and illegality, projections and matters in fact known to the insured party (typically but not always the buyer).

Areas where coverages vary, aside from amounts and premiums of course: the period of time in which a claim must be made; how large a claim must be before it is covered; whether the insurance pays first dollars of any claim or kicks in only once the seller’s indemnity obligations have been fully paid; whether particular areas are expressly excluded from insurance, such as particularized atypical representations.

As policy availability has moved down the food chain and become available for lower middle market deals, the market’s familiarity with this tool, beyond the PE fund acquirer, will no doubt increase.  These days, M&A counsel typically will at least alert clients to this deal tool on each side of a proposed transaction.

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