It is estimated that 1 in 5 M&A deals encounter issues prior to closing date. Yet this figure doesn’t include discrepancies discovered prior to an agreement being reached, which can often end the purchase process entirely. Due to the later, there is a significant emerging trend in the use of M&A representations and warranties (R&W) insurance in mergers and acquisitions of privately held companies. Both strategic acquirers and private equity buyers have gotten comfortable in using such insurance for their acquisitions, providing meaningful benefits to both the buyer and seller in an acquisition. Rather than hold a significant amount of funds in a temporary escrow (typically 10% to 15% for one to two years), it is possible to purchase insurance that can help to mitigate potential risks. The emerging use of R&W insurance is modifying or eliminating this traditional structure.
R&W insurance is an insurance policy used in M&A transactions to protect against losses arising due to the seller’s breach of certain of its representations in the acquisition agreement. The insurance is playing an increasing role in M&A transactions by allowing cleaner and strategically enhanced exits and securing better deal terms by helping to mitigate unforeseen liabilities arising from breaches of the seller’s R&W, overcome deal breaker issues and supporting beneficial deal terms between the seller and the buyer without increasing any of the party’s liability.
Is the R&W insurance can change due diligence? Unfortunately, not. In fact, the information of the executed due diligence will be essential for the insurer to negotiate the specific terms of the insurance policy, such as the scope of losses included within coverage and excluded from coverage.
Where the R&W insurance has become a practice in M&A deals? Although this practice is not widespread in Lithuania so far, in fact, none of the biggest insurance companies in Lithuania directly offers this type of insurance (however the insurance can be bought through the insurance brokers), in the America’s and Western Europe M&A market, where the size of transaction and pressure to execute the transaction quickly does a bear’s service, the dealmakers are more and more relying on the R&W insurance. AIG (American International Group) 2018 claims study shows 43% average distribution of insurance policies in M&A deals up to $ 100M with the 17% average of policies receiving a claim. The respective study also shows the tendency between the bigger M&A deal size and bigger percentage of the claims received post transaction. The most common claims to date have revolved around the representations and warranties related to accuracy and completeness of financial statements, disclosure of material contracts, compliance with laws and tax implications with an average payout of $ 19M.
Considering that fact that the most R&W insurance policies uses an arbitration clause in the event of the dispute, publicly available case law on this issue is almost non-existent, the R&W insurance in M&A transactions still remains in a grey area, however, it is likely that in the coming years the tendency of R&W insurance in M&A transaction is of a great potential to come to Lithuania.
This article has been created by Daina Senapėdienė and Agnė Jakštaitė, Corporate and M&A team members of CEE Attorneys.