In recent months, high profile M&A warranty claims  and falling premiums have dramatically increased the utilization of "representations and warranty insurance" (RWI), also known as "warranty and indemnity insurance," in mergers, acquisitions and related transactions. By one account, demand for transactional risk insurance policy limits in North America grew by eighty-six percent (86%) in 2012.  Yet, due to the relatively recent popularity of RWI policies and the fact that such products may vary by transaction, many private equity firms, corporate risk managers and M&A attorneys are largely unfamiliar with the benefits and potential hazards in obtaining RWI policies. Here are ten tips for corporate dealmakers and M&A counsel for purchasing and negotiating RWI and related transactional insurance policies.
1. Interaction between RWI and PSA. When it comes time to make a claim under either a "buyer-side" or "seller-side" RWI policy, coverage will be determined by the four corners of the policy - not the underlying purchase and sale agreement (PSA). Make sure that the insuring agreement, policy definitions and conditions accurately reflect the allocation of risk and liability between the insurer, buyer and seller, independent of the underlying indemnities or other terms of the transaction. Alternatively, as appropriate, incorporate the terms of the underlying PSA into the policy or otherwise ensure that the scope of "loss" mirrors the damages, defense costs, or other amounts to which the buyer/seller would be entitled/obligated in the event of a breach.
2. "Buyer-Side" versus "Seller-Side" Coverage. As a general rule, the coverage under a "buyer-side" policy - which may apply irrespective of the knowledge of the seller - may be broader than the coverage available through a "seller-side" policy - which may only respond in the event of a third-party claim, and then only absent the prior knowledge or improper intent of the seller. While every transaction and every policy is unique, all other things being equal, opting for "buyer-side" coverage may avoid complications over what the seller knew or did not know in the event of a claim or breach.
3. Self-Insured Retention. Most RWI policies require some form of self-insured retention to be satisfied before the insurer's coverage obligations will incept. In the event that more than one policy may respond to a particular breach or third-party claim, consider whether the terms of the RWI policy allow other insurance or even other parties (buyer, seller, or third-party) to satisfy the retention on behalf of the insured. As appropriate, clarifying language should be added to the RWI policy.
4. Subrogation. In the event of a breach, the RWI insurer will either be equitably or contractually subrogated against the party responsible for the loss payable to the insured. Although RWI sometimes can be seen as a replacement for a transactional indemnity, sellers should consider whether, under applicable law, capping or defining an indemnity obligation narrowly in the PSA is preferable, in a subrogation context, to leaving a seller's obligations undefined by eliminating any contractual indemnity. Buyers should likewise ensure that the RWI policy covers the cost of defending against counterclaims in the event of a subrogation action against a seller.
5. Who Is Insured? Depending on the nature of the transaction, the party purchasing a RWI policy and paying the premium may not be the intended insured. Parties must be vigilant to confirm that (1) the insureds under a "seller-side" policy include all potential defendants in a future claim for breach of warranty; and (2) the insureds under a "buyer-side" policy include all parties that could potentially sustain loss, including defense costs, in the event of a future breach - including entities that may be expiring, surviving or created in the subject transaction.
6. RWI as a Value-Add. In some transactions, the role of RWI will be known and even funded by both buyer and seller. In other cases, RWI can be used to add value to the transaction for parties on either side of the deal. Premiums for RWI, depending on the nature of the transaction, may range between 1 percent and 3 percent of policy limits. If the seller refuses to provide a sufficient warranty, the buyer may negotiate a reduction in the purchase price that exceeds the additional cost in premium to secure RWI, thereby creating a net benefit to the buyer. Alternatively, the seller may demand additional consideration for enhanced representations that may more than offset the cost of transferring the risk of a breach through RWI. Parties should consider ways to use RWI, not only to overcome obstacles to completing a transaction, but also to add value to a deal.
7. Privilege and Non-Disclosure. Most insurers' underwriting shadows the diligence performed by the transactional parties themselves. The underwriting carrier may have access to a dataroom, including attorney-client communications, work product, and the insured's own due diligence materials. Transactional parties should carefully consider how to protect the integrity of the attorney-client privilege, including, where appropriate, by adding a non-waiver provision to the PSA, and at a minimum negotiating an appropriate confidentiality agreement with the insurer before providing sensitive disclosures in underwriting.
8. Arbitration. Arbitration provisions in RWI policies are common as are choice-of-law provisions designating New York or even a foreign jurisdiction as the governing law for disputes over the construction, validity and performance of the insurance contract. Policyholders should carefully weigh the potential advantages of arbitration against the possible disadvantages of forfeiting a right to a jury trial or certain remedies that may not be permitted in arbitration. Insureds should also consider alternative choice-of-law designations favoring jurisdictions in which the insured is located or incorporated. If avoiding arbitration is not possible, the procedure required in a RWI policy should be modified to allow the insured greater control over the process, including by allowing each side to select a non-neutral arbitrator, requiring expedited discovery and hearing at a location of the insured's choosing, or expressly authorizing awards of attorneys' fees and/or exemplary damages.
9. Timing Issues. RWI policies are written on a claims-made basis, whereby coverage is only triggered by a loss or claim occurring within the defined policy period. Purchasers should ensure that the "policy period" within which a claim must be made is commensurate with the limitations period for claims for breach of contract, negligent misrepresentation and other claims likely to arise from a failed warranty or representation in the applicable jurisdiction. When in doubt, insureds should provide notice of even potential breaches/claims not only to ensure timely reporting, but to secure a place within the policy period for future related claims, breaches or loss - whether occurring before or after the policy period "expires."
10. "Fraud" Exclusions. Most "buyer" and "seller" RWI policies will have some form of exclusion denying coverage in the event that an insured had knowledge of a breach prior to the inception of the policy, or, in the case of a "seller-side" policy to the extent that the seller committed fraud in connection with the underlying transaction. In traditional D&O policies, similarly framed "fraud" exclusions are qualified to apply only in the event that a final, non-appealable adjudication in a liability (as opposed to coverage) action establishes that the alleged "fraud" actually occurred. Likewise, "fraud" and knowledge-based exclusions in both "buyer-side" and "seller-side" RWI policies should also be constrained by "final adjudication" language. Appropriate severability language should also be included.
 See, e.g., Liberty Media Corp. v. Vivendi Universal, S.A., 2013 WL 105776 (S.D.N.Y. Jan. 9, 2013) (ordering the entry of judgment in the amount of €765 million against Vivendi for, inter alia, breach of four express warranties in a 2001 merger agreement).
 See Marsh Insights: M&A Transactional Risk Solutions: 2012 Global Review (March 2013).
Micah E. Skidmore, Partner, firstname.lastname@example.org
Micah E. Skidmore is a partner in the Insurance Coverage Group at Haynes and Boone, LLP. Micah represents corporate policyholders in significant insurance coverage disputes, including assistance in recovering defense costs, settlements, judgments and other losses under various types of insurance policies. In addition to representing clients in general business litigation matters, Micah also advises clients on insurance and indemnity issues in corporate transactions, including mergers, acquisitions and real estate transactions.
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Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Haynes and Boone, LLP. This work reflects the law at the time of writing.