During the course of an M&A transaction, it is often the case that the most hotly negotiated aspects of a purchase agreement are the representations and warranties and related indemnities. This is not surprising as these are the key devices used to address allocation of risk as between the parties, and by extension, price. While buyers want the security and protection of knowing they paid for what they thought they were buying (essentially minimizing surprises post-closing), sellers often desire a clean exit from the transaction. Parsing though these competing objectives can be time consuming, costly and may hinder a deal.
One possible option is to introduce a third party to share in the risk burden by way of insurance. Many insurance companies offer transactional insurance products such as representation and warranty insurance, tax liability insurance, contingent liability insurance and litigation buyout insurance and its use is becoming more prevalent in the Canadian marketplace.
Benefits of insurance
Transactional insurance may be purchased by either buyers or sellers to protect against loss resulting from a breach of warranty or claim on an indemnity, and is used as an alternative to the contractual mechanisms for claims contained within purchase agreements.
Buyers may benefit from transactional insurance in circumstances where they desire to enhance the amount or duration of representations or indemnities beyond what the seller is willing to offer. Transaction insurance may also allow a buyer to craft a more distinctive and attractive bid in an auction process as insurance can create certainty of purchase price by allowing a buyer to reduce or eliminate escrow requirements. Insurance can also operate to ameliorate collection concerns when dealing with sellers out of reach of local courts or that may not exist post-closing, to protect key relationships that may be tarnished though indemnity claims where, for instance, employees of a seller may remain employed to operate the business, and to simply avoid drawn out negotiations.
Sellers on the other hand may seek insurance to avoid significant escrows of purchase price such as where a payoff of existing debt or a distribution of investor proceeds must occur on closing. Sellers may also look to supplement the disclosure process and avoid unintentional non-disclosures, to reduce contingent liabilities and to expedite a sale.
Additional considerations
Transactional insurance is a highly customized product that may be useful in a variety of transactions, if for nothing more to better understand the pricing of risk which will aid in the parties negotiations. As with any insurance there are of course costs to be considered as well, and in this instance aside from the obvious cost of premiums the parties will also be responsible for the legal costs of the insurer's independent legal counsel. Typically such legal counsel will charge a flat fee and will maximize efficiencies by working closely with buyers and sellers legal counsel. Buyers and sellers should also be familiar with the coverage limits of the insurance policy (especially exclusions) and understand that there is no substitute for appropriate due diligence.
For more on representations and warranties insurance, please see our previous post on this topic.
Norton Rose Fulbright Canada LLP
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