Use of Representations and Warranties Insurance (RWI) has exploded within middlemarket M&A during the current economic cycle. Here are some perspectives from our M&A team, gained by leading buy- and sell-side transactions using the product and through market intelligence from agents and insurers:

1. RWI is now being used in transactions with targets priced as low as $20 million enterprise value. There is an inflection point where the premium and added procedure will not be supportable in the lower ends of the middle market, but it seems we’re not there yet. Exiting the Great Recession, the prevailing view was that the product would not be viable below $100 million enterprise value.

2. In a competitive sale process, use of RWI where the acquirer pays all of the premium is commonplace, to the point it no longer is a significant bid differentiator. In a one-off transaction, it is generally more difficult to require the buyer to use RWI. Use by strategic acquirers is increasing as a percentage of total RWI policies underwritten (estimated to be approximately 40% of all RWI issued in 2018), but their experience using RWI, even sizeable publicly traded or privately held acquirers, can be spotty, making use of the product more challenging.

3. Premiums, coverage limits (transactions with an aggregate of $1 billion or more of risk transferred to the insurers, and growing, are now achievable), covered industries and other coverage terms continue to evolve in favor of buyers/insureds, as more insurers enter the competitive marketplace (currently 20+ globally).

4. Pro-insured developments in the product include (i) full “walk away” transactions for sellers, (ii) coverages across multiple jurisdictions in cross-border transactions, (iii) coverage for targets in industries that were formerly difficult to obtain (e.g., health care), and (iv) coverage for “interim breaches” – new issues that develop between signing and closing.

5. Sectors of the space express discomfort with the concept of full “walk away” RWI. In this most seller-favorable version of the product, sellers have no liability post-closing for unknown issues affecting their company, absent fraud. The more traditional and, at least at this point, more utilized product would require sellers to bear the risk for approximately one-half of the retention for the RWI, typically 1% of enterprise value.

6. The scope of the policy is largely driven by the quality and breadth of buyer’s due diligence effort, placing greater emphasis on the due diligence process, even for buyers who would otherwise be inclined to take a less rigorous approach. It can be challenging to find an insurer to underwrite the risk underlying areas not addressed in due diligence. While also evolving in favor of buyers/ insureds by loosening the requirement, insurers have favored targets with audited financial statements and a comprehensive due diligence report prepared by buyer’s outside counsel and other consultants across relevant subject matter areas.

7. More often than not, insurers are opting to define covered “losses” generally and, of note, without a specific inclusion or disclaimer of the most controversial types of consequential damages – multiples of earnings, diminution in value and lost profits. This is to say, the insurers will allow a claim from their buyer-insured that includes these categories of damages, and then negotiate over whether causation and loss have been established to the standards of a common law contract claim. In this manner, the insurance terms track our experience in negotiating this definition in a traditional indemnification regime.

8. “Fraud” is a risk always retained by the sellers and is the most common instance in which the insurers reserve the right to assert claims directly against sellers, even where buyer has not or is unwilling to do so. Sellers who are not experienced in M&A often dismiss this risk – of course we wouldn’t be engaged in that type of conduct! However, in the context of a definitive purchase agreement that includes pages of representations and warranties about their business, and volumes of due diligence, negotiation and communications that preceded the sale, the importance of this exclusion should not be overlooked, and is why this definition has become a significant negotiated item. In our experience, the insurer will agree to incorporate the definition of fraud agreed to by seller and buyer for purposes of the RWI subrogation provision.

9. Insurers and agents are sensitive to the inevitable collectability question – in other words, as a buyer, if I have the choice, am I better off making my claim against the RWI or a traditional escrow and/or the sellers personally? Agents have internal claims assistance teams to help their insureds pursue their claims and highlight claim success stories. The product is arguably relatively nascent and claims history relatively opaque to potential insureds.

10. The current era of RWI has not yet experienced a down cycle in M&A, and we will watch closely how shifts in bargaining leverage affect the product.