April 22, 2024

Rep & Warranty Insurance: Is the Bloom off the Rose?

The rise of RWI has been one of the biggest stories in private M&A over the past decade or so, but according to a recent SRS Acquiom study, RWI usage on private deals appears to be plateauing. The study says that post-closing issues may be a big reason that dealmakers have tempered their enthusiasm for RWI. This excerpt highlights some of the specific concerns for sellers in deals using RWI:

Indemnification escrows are seldom returned to the sellers on deals with an RWI claim.

— Buyers could be highly motivated to quickly burn through the RWI retention amount to unlock coverage under the policy.

— Nearly half of deals with RWI include a general indemnification escrow as security for the sellers’ portion of the RWI retention.

Sellers and the shareholder representative may not be privy to claims made under the RWI policy since buyers are often the named insured.

— Buyers may fully exhaust RWI coverage before sellers are even aware there has been a claim, at which point sellers may be on the hook again.

— RWI providers are not as familiar with the target’s operations and financials and may not be able to defend against a claim as well as the sellers and shareholder representative.

RWI can add varying levels of complexity.

— When making a large claim against the policy, buyers may employ full resources, which could dramatically outweigh the resources available to sellers to defend the much smaller indemnification escrow amount (or the risk of losing such escrow might not outweigh the cost to launch such a defense).

— Sellers may still be on the hook for indemnification claims excluded from RWI coverage or when RWI coverage is exhausted and may end up going out of pocket, especially if the deal had a smaller indemnification escrow.

It isn’t just sellers who have reason to think a little harder about using RWI in a deal. That’s because RWI’s evolution in recent years toward becoming a commodity product hasn’t been good news for buyers.

John Jenkins