In each M&A transaction, it is of great importance for all parties to determine the risks to which they are exposed. This is the reason why representations and warranties form such a major part in all SPA discussions.
Thus, insurers have come up with an insurance instrument with respect to the agreed upon R&Ws, protecting the insured person from damages caused by a breach of these R&Ws. This instrument has been used for the past 15 years, whereas in the last three there has been a significant increase in its utilization. Particularly in the United States, the number of deals employing R&Ws insurances has increased twice since 2013 and the value of the insurance premiums has exceeded USD 6 billion.
The R&Ws can be concluded in favor of either party under the transaction, depending on their relations and the aims they want to achieve. As a tool for t splitting the risk, this insurance can be used in a large specter of deals, whereas the details depend on the particulars of the transaction in question.
Negotiations of the R&Ws clauses, as well as the ones related to damages, always put the parties’ nerves to the test. The seller will want to give R&Ws with limited scope and very specific in relation to breaches, which shall render the payment of damages. On the other hand, the buyer will be interested in having all-encompassing R&Ws, in order to be protected against damages occurring post-closing. The R&Ws insurance balances the position of both parties and allows them to concentrate on the other aspects of the transaction, which in turn leads to more effective negotiations.
Benefits for the parties
In case the seller does not want to be exposed to the risk of potential obligation for payment of damages, which can occur after closing, the R&Ws insurance transfers this risk to the insurer. Thus, the direct liability of the seller is limited, which in turn allows it to use immediately the income from the sale without the need of provisioning for potential indemnifications. A particular advantage for investment funds is the opportunity to invest freely the received amounts or to distribute them as dividends to shareholders. In addition, the need for depositing amounts to an escrow account is limited or entirely removed.
Further, the buyer receives the desired set of representations and warranties and can more easily expand the scope of the liability clauses without the need of making concessions. Additionally, the insurance can be helpful in increasing the period for which the representations and warranties are valid, which will give the buyer more time to discover potential violations and to take timely actions.
Next, in case of a tender procedure, the use of insurance can allow a particular buyer to be in a competitive position and to offer better conditions than the other participants.
The opportunity for the seller to claim indemnifications directly from the insurer and not from the seller, furthers the negotiation of wider levels of liability than having no insurance and removes any concerns regarding the solvency of the seller in case of breach of R&Ws.
Insurance coverage, conditions and premium
The insurance can cover (i) representations and warranties agreed upon in the SPA, or (ii) specifically defined representations and warranties.
In most cases, the amount of the insurance coverage is: (i) in insurances in favor of the seller, usually equal to the amount of the agreed upon compensations, and (ii) in insurances in favor of the buyer, usually equal to 10% of the purchase price.
The due insurance premium most commonly bears between 2% and 4% of the insurance coverage, whereas the premiums for insurances in favor of the buyer are a little bit more expensive when compared to insurances in favor of the seller. It is common practice the premium to be paid upon closing, while which party is liable for it depends on the commercial understanding of the participants.
Normally , the insurance coverage starts from closing, but there are specific insurances in favor of the buyer that provide coverage of specific breaches, discovered prior to closing the deal.
In case of insurance in favor of the buyer, it can be further agreed that the effective period of the insurance exceeds the effective period of the seller's R&Ws; in respect of the seller, it is common that both periods to be equal.
Legal and tax consultants play an important role in cases where R&W insurances are used. Due to the allocation of risk to the insurer, it is common practice for it to hire law and tax consultants in order to define more precisely the terms and conditions of the insurance.
Application and limitations
Such type of insurance does not cover all types of damages, where common exceptions are damages related to price fluctuations, violations of other provisions of the agreement, insurer’s fraud, etc. Matters related to the environment and tax obligations occurring as a result of the transaction are also usually excluded from the scope.
Damages that result from matters known by the insurer at the time of conclusion of the agreement are also not covered.
Application in Bulgaria
Currently, no insurer on the local market offers such type of insurance. However, there are no obstacles for the parties to a transaction concluded in Bulgaria to contact a foreign insurer with experience in the area. A partial reason for not having these insurances in Bulgaria is the value of most deals on the market, since insurers offer the instrument where the range is between EUR 20–500 million.
No doubt, for the foreign investors interested in purchasing assets in Bulgaria, this insurance can be an extremely useful instrument providing them with additional protection.
It should be mentioned that the decrease of the premium, the specification of the insurance terms and conditions, as well as the competition in the offering of this product makes the insurances more accessible and used method for re-distribution of risk. This type of insurances is widely used in transactions in specific regions, taking into consideration their benefits for both the seller and the buyer, and probably soon it will become a standard tool used in Bulgaria as well.
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