Reps & Warranties Insurances
Authors: Dr. Silvia Wandl; Dr. Matthias Trummer, MSc; Dr. Krzysztof Nowak, LL.M.; Mag. Katharina Seethaler, LL.M.
Reps & warranties insurances can simplify, accelerate and increase the value of M&A transactions. These insurances are able to help resolve or soften conflicts of interest between buyers and sellers. To facilitate a smooth process of taking up a reps & warranties insurance coverage, the involvement of an insurance broker should take place as early as possible.
Please refer to our previous blog post to learn more about what reps & warranties insurances are for, the insurable risks and how to obtain insurance coverage.
What are the core components of reps & warranties insurances?
Reps & warranties insurances are tailor-made for each transaction. Therefore, the premium and coverage level varies from case to case depending on the industry, transaction risk and volume.
The coverage level is expressed as percentage of the company value (currently around 10-50%) and can amount to even EUR 500 million. In case of high coverage levels, in order to split the risk between several insurers, they may decide to construe a syndicate.
Reps & warranties insurances have become more cost-effective in recent years. The current premium is usually 1-2% of the desired coverage level. The costs of the insurance broker are usually covered by the premium. In practice, the premium can also be split between buyer and seller.
Deductibles have also decreased significantly in recent years and currently amount to approximately 0.5-1% of the company value. The trend is towards the complete elimination of deductibles.
The main reason for lower premiums and deductibles is increasing competition. In recent years, many new providers have entered the market with the aim of gaining market share through lower prices.
Due to the substantial costs involved, private equity companies have traditionally been almost the only ones to make use of reps & warranties insurances. Due to increased competition and cost reductions, there is currently a growing tendency towards insuring also the risks arising from small and medium-sized transactions. This is because also for these transactions the desire for a clean exit steadily increases.
How does the claims settlement work?
In case of a breach of warranty, the buyer does not have to contact the seller but rather the insurer directly. Unlike a seller, the insurer is usually not interested in remedying the defect itself in natura (in form of a restitution in kind). Hence, the buyer’s claim will be for payment of a sum of money. The insurer may – just like the seller –acknowledge or dispute the claim.
The insurer will only be entitled to recourse against the seller in the event of intent or deceit on part of the latter.
What are the advantages of a reps & warranties insurance?
Reps & warranties insurances eliminate conflicts of interest between buyer and seller in the process of negotiating the warranty catalogue. This practice generally accelerates the transaction process and simplifies the negotiation of the warranty catalogue to be included in the transaction documentation.
In many transactions, entire seller’s liability risks can be covered by concluding a reps & warranties insurance. Generally, this is the most important advantage for the buyer. Additionally, the buyer (usually) has a liquid debtor – the insurer – at his disposal in the event of a claim. He has a direct claim against the insurer and does not have to make a prior claim against the seller under the contract.
Reps & warranties insurances are particularly relevant for all those cases where the buyer is unwilling to assume risks under the business-related guarantees. In practice, it is also advisable to conclude such insurance if the enforceability of claims against the seller is doubtful (e.g. if the seller intends to pay out the transaction price to investors following the transaction and is then to be liquidated).
The conclusion of a reps & warranties insurance also satisfies the requirements of new groups of buyers. This might be crucial for – generally less risk-averse – Asian investors, who have been investing increasingly in the European market in recent years.
Moreover, sellers are frequently prepared to accept a comprehensive warranty catalogue if insurance cover is in place.
The conclusion of a reps & warranties insurance enables the seller a so-called clean exit. In other words, the seller receives the entire purchase price immediately upon closing, without part of it being “frozen” on an escrow account for potential warranty claims.
Furthermore, buyers with additional access to insurers are likely to accept a lower liability cap from sellers (up to no liability or “EUR 1” liability).
Reps & warranties insurances can also serve a role in structured sales processes. The envisaged conclusion of a reps & warranties insurance might possibly result in better offers. In this case, the seller usually initiates the negotiation of the policy in course of the auction. Subsequently, a buyer takes over the policy or its negotiation is taken over by potential buyers at a later stage of the process (stapled policies).
PwC Legal Austria has extensive experience in working with insurance brokers and we are happy to support you in the selection of the most suitable insurer for your M&A transaction.
