December 8, 2017

R&W Insurance: Private M&A’s “New Normal”

I recently had a conversation with one of my colleagues about negotiations with a seller’s counsel in a private company deal. He sent out a buyer-favorable purchase agreement to seller’s counsel – but the deal contemplated rep & warranty insurance with no indemnity strip from the seller.

When my colleague negotiated with the seller’s lawyer on the reps & warranties, the other lawyer said at one point, “I suppose I could mark a lot of these up, but I’m not sure that I care.” The seller’s lawyer was being a bit facetious, but his comments illustrate what’s become the “new normal” in negotiating deals backed by R&W insurance. To put it simply, the tough negotiations on reps and warranties often take place between the buyer and the insurance company, not the buyer and the seller.

This Gibson Dunn memo reviews how the R&W insurance market has evolved in recent years, and the effect that the availability of that insurance is having on how parties to the deal allocate risks. Here’s an excerpt that discusses the benefits of a “no survival deal” with an R&W policy:

While limiting the seller indemnity can meaningfully shorten the negotiation timeline, eliminating it entirely can dramatically simplify negotiations.

For example, even in a $100 million transaction, the respective deal teams can spend a surprising amount of time negotiation a $500,000 indemnity strip. Eliminating the seller indemnity can also enhance the buyer’s coverage under the RWI policy.

Most policies will include two types of “coverage enhancement.” First, they will include a “full materiality scrape” – i.e., they will “read out” materiality qualifiers in the reps for purposes of determining whether a rep has been breached and the amount of losses resulting fom such a breach. Second, they will not impose a “damages exclusion” on the buyer’s recovery – i.e., they will cover a range of damages, including consequential damages and those based on multiples of earnings and lost profits.

In a no-survival deal, most RWI policies will include these coverage enhancements as a matter of course (that said, before including a materiality scrape, the insurer will want to confirm that the seller has populated the disclosure schedule without regard to the materiality qualifiers in the reps).

What’s interesting is that insurers are less generous with coverage enhancements in the case of deals with an indemnity strip. In these situations, they general require that the seller agree to a full materiality scrape and the absence of a damage exclusion.

The memo also addresses some of the limitations on R&W insurance and alternative methods of addressing gaps in coverage.

John Jenkins