R&W insurance – No longer the pink elephant of M&A in Belgium?
Over the last decade, the idea of a R&W insurance (representations and warranties insurance) was often entertained in Belgian M&A transactions, but it was not used on a regular basis. It was considered to be the “pink elephant” of M&A because its name echoed in the halls but its application was very limited. However, recent statistics show Belgium is catching up with its neighbours, such as the Netherlands, where R&W insurance has become relatively standard in transactions, especially when dealing with investors and private equity.
In (almost) every M&A transaction, the seller will be expected to provide (and thus be liable for) certain representations and warranties to the buyer in respect of the pre-transaction conduct of business. The discussions in respect of the wording of the representations and warranties, and the extent and limits of the seller’s liability for those representations and warranties are the most difficult part of any M&A negotiation. Indeed, when it comes to the representations and warranties, the interests of the seller and the buyer are diametrically opposite. While the seller will want to avoid as much liability as possible, the buyer will want as much of the pre-transaction conduct of business as possible covered by the representations and warranties.
R&W insurance might just bridge the gap between the seller and the buyer. It is an insurance product intended to protect against unanticipated losses resulting from events or circumstances which constitute a breach of the representations and warranties. Two main categories of R&W insurance can be identified: the sell-side or the buy-side R&W insurance. In a sell-side policy, the seller is the policyholder and beneficiary of the insurance. This means that if a post-transaction claim for breach of representations and warranties arises, the buyer will claim from the seller and subsequently the seller will claim from the insurance company. In the buy-side policy, the buyer takes out the policy and is the beneficiary thereof. Thus, in the event of a claim for breach of representations and warranties, the buyer will directly file its claim with the insurer.
Although there is still some (unjustified) scepticism surrounding R&W insurance in the Belgian M&A practice, we have seen that its application entails considerable benefits for the transaction process and the parties.
- R&W insurance allows the seller to pursue a “clean” exit, with little to no liability for representations and warranties. Although this is particularly important for private equity sellers, R&W insurance is not exclusively designed for private equity deals. The objective to reduce to the fullest extent possible the risk associated with representations and warranties should be top of mind for any seller of a company.
- R&W insurance also solves the buyer’s concern of recoverability and security. The seller’s credit will be replaced by the credit of a rated insurance company. This immediately lessens the need for huge escrows or other security mechanisms as a way of dealing with these types of concerns.
- The discussions regarding the extent of the seller’s liability for the pre-transaction conduct of business can get tense at times. Introducing R&W insurance into the mix can have a positive effect on the level of comfort for both the seller and the buyer, and therefore on the timeframe of the transaction.
- When a company is sold, the seller sometimes reinvests part of the proceeds in the company or only sells a majority stake to the buyer, and/or the seller takes up a (transitional or even more permanent) management role in the company sold. In the event of a breach of the representations and warranties, the buyer will, in the absence of R&W insurance, have to pursue the rather inelegant legal route of filing a claim against (the seller who is also) his co-shareholder or the manager of his company. This may have a severe impact on the relationship, the future cooperation and even the company. Buy-side R&W insurance “depersonalises” these discussions by shifting the financial burden to the insurer.
Although R&W insurance has clear benefits, there are some basic guidelines to be kept in mind.
- The interaction between the terms and conditions of the share/asset purchase agreement and the R&W insurance policy is fundamental. This will require a whole set of issues to be tackled, such as: Which exclusions are provided in the R&W insurance?; Who will be liable for these exclusions?; Is recourse against the seller beyond the limits of the R&W insurance possible?; What if a warranty is given under the purchase agreement but is not covered by the insurance?; What if the time limit of coverage by the insurer is shorter than the time limits provided for in the purchase agreement and vice versa? It requires skill and expertise to ensure that the purchase agreement and the policy are seamlessly integrated. Any gaps between both documents may result in residuary liability for the seller.
- Although a number of “classic” heavy negotiation topics in a M&A deal will likely become irrelevant (e.g. escrow, maximum liability cap), new discussions, linked to the R&W insurance itself, will arise between the parties but also with the insurer, e.g. the amount of the premium of the insurance, the applicable retention (franchise) and other financial and time limitations under the policy.
- Finally, R&W insurance is not a magic solution when a far-advanced deal is about to go wrong. The parties should keep in mind and be prepared for the fact that the insurance company will require vendor due diligence reports or access to the due diligence reports prepared by the buyer’s advisors. Both the quality of the information provided during the due diligence exercise and the quality of the diligence exercise itself shall to a large extent determine the insurability of the deal. Given the insurer’s due diligence requirements, it is recommendable to introduce the concept of the R&W insurance early on in the negotiation process and to get the insurer involved in the deal as soon as possible. If the seller introduces the idea of a buy-side R&W insurance, the seller can opt for a soft-stapled variant (this means the seller does the preparatory work for the policy but leaves it up to the buyer to finalise the policy with the insurer) or a hard-stapled variant (this means the representations and warranties and the policy are fully negotiated by the seller and are presented as a take-it-or-leave-it-package for the buyer). The latter will likely only be possible in a very competitive auction process.
Despite of initial scepticism, the Belgian M&A practice finally seems to have embraced R&W insurance as a valuable tool in M&A transactions. When applying R&W insurance in a transaction process, it is definitely key to plan ahead and to integrate this workstream into the overall transaction process. It is equally important to find a good and workable fit between the purchase agreement and the insurance policy.
Does R&W insurance still have some pink elephant-like features to you and do you want to know more? Or are you contemplating to use R&W insurance in your deal? Four & Five would be happy to advise you!
Auteurs: Lauranne Van den Maegdenbergh en Dimitri Coun