Insurance Requirements When Undergoing an M&A
Mergers and acquisitions (M&As) have become increasingly common in the last few decades, hitting new highs in 2021 and bringing in trillions of dollars. In fact, according to PWC, 62,000 M&A deals took place globally—a 24% rise since 2020.
Many company leaders are excited about this rise in opportunity, and they should be! However, company leaders should also be familiar with the insurance requirements before undergoing an M&A. The right insurance policies can significantly change the outcome of the deal.
Read on to learn how to protect leaders with directors and operators insurance (D&O) and drive your deal toward a smooth and successful transition with representations and warranties insurance (RWI).
Protect Leaders with Directors and Operators Insurance
D&O insurance serves to protect directors and officers. This policy covers these team members if they are named as individual defendants in lawsuits, for acts taken in their professional roles at the company.
What Does Directors and Operators Insurance Cover?
D&O insurance protects the directors and operators in the event of lawsuits from:
- Other parties
D&O policies typically provide coverage for costs associated with lawsuits, such as legal fees, settlements, and more. Additionally, some D&O policies may also provide some form of coverage for the company.
Advantages of Directors and Operators Insurance in M&A
D&O insurance policies typically insure against certain “Wrongful Acts” as defined by the policy that the company or other parties allegedly commit.
According to American Bar, these policies commonly contain a “change in control” provision that “limits the available coverage for these ‘Wrongful Acts’ if there is a change in company ownership.”
Before any M&A, participating parties should understand any change in control provisions and invest in coverage for their leaders with D&O insurance.
Additionally, some directors and officers may be entitled to indemnification from the company through employment contracts or company bylaws. If so, those indemnity obligations are typically backed financially by a D&O policy.
Let’s Talk About Representations and Warranties Insurance
A few decades ago, company leaders rarely invested in representations and warranties insurance (RWI) to protect their companies during an M&A transaction.
However, in recent years, RWI has been a rising solution to the unknown liabilities and risks of M&As. Company leaders use RWI as a tool to transfer risk to an insurer and enhance the value of their deals.
What Are Representations and Warranties?
First things first, what are representations and warranties? This term, of course, can be broken into two sections: representations and warranties.
Representations are assertions as to a fact that is given to another party. These representations are given to induce another party into taking a particular action, such as entering a contract.
Warranties are promises of indemnity if the assertions are false or wrong. Therefore, if the representation is false, it’s “inaccurate,” but if a warranty is false, it’s “breached.”
In simple terms, representations and warranties provide sellers with the opportunity to provide accurate information and disclose any issues about their company. From this information, the buyer can correctly estimate the value of the company and know what they are getting into.
What Is Representations and Warranties Insurance?
Representations and warranties insurance, also called reps and warranties insurance or RWI, is a policy purchased for corporate transactions.
Forbes defines reps and warranties insurance as “an insurance policy used in mergers and acquisitions to protect against losses arising due to the seller’s breach of certain of its representations in the acquisition agreement.
Advantages of RWI in an M&A
RWI has several benefits during an M&A transaction for both the buyer and seller.
For the Seller: Early Termination of Escrow
Representations and warranties insurance allows for the escrow to end sooner.
For the Buyer: A Longer Survival Period for the Indemnification of Breaches
For the acquiring party, RWI typically provides:
- Six years of coverage for breaches of fundamental and tax representations, and
- Three years of coverage for non-fundamental reps
Additionally, the buyer can purchase limits on the policy to exceed the cap on the seller’s obligations surrounding indemnification.
For the Seller: Limiting Liability with an Indemnity “Strip” or “No Survival” Deal
Parties might agree to reduce or eliminate the seller’s liability for certain representation breaches.
In an indemnity strip, the retention will “drop down” to a reduced amount after a set period of time. For instance, the retention may drop after one year of closing.
In a “no-survival” deal, some or all of the seller’s reps do not survive the closing.
For the Buyer: Distinguishing Their Bid
RWI can help set the buyer’s bid apart from the competition in the auction process. Additionally, RWI can:
- Make the bid more attractive to the seller because of its economic benefits
- Shorten negotiations or increase efficiency over the acquisition agreement
Undergoing an M&A?
Your business changes regularly, and so should your understanding of your insurance coverage. You run a business with complexity; at Apex Risk & Insurance Services, we provide custom solutions to meet your insurance needs.
Read on to learn more about who we work with or contact us for more information on how to protect your business and how to experience an efficient transition when you partner with us.
Lastly, read on if you’re interested in our executive protection policies.