Insights

With Rep and Warranty Claims, It Pays to “Spill Your Guts” to Your Insurer
POSTED 3.7.18 M&A

When it comes to standard car, home, or health insurance, policyholders tend to play it close to the vest.

They won’t freely give information above what the insurance company requires, and if the insurer starts asking questions, especially about a claim, they get downright defensive.

They’re worried the company is trying to deny a claim or exclude something from their policy. A policyholder’s biggest fear is not getting paid when they actually want to use the insurance they’ve been paying premiums for. Hey, it does happen.

But don’t let that practice affect how you view your Representations and Warranties insurance (R&W). This is coverage you take on when going through a major merger or acquisition deal.

As you’ll see in a moment, it’s worlds apart from standard insurance practices… these claims do get paid, especially when you work closely with the insurer and give them the information they need, so they can “get it right”.

To give you some background, R&W policies are designed to protect the parties in an M&A transaction from a financial loss resulting from a breach of the Sellers’ representations outlined in a purchase and sale agreement. R&W protection is now available for transactions from $20M up to $1B+ in value.

This coverage gives peace of mind to the Buyer and Seller. R&W transfers the indemnity obligation away from the Seller and over to an insurance company. As I’ll detail shortly, the Buyer is assured of immediate remedy in the event of a breach.

If there is a breach of representation or warranty, the Buyer simply turns to the insurance company to pay the financial losses, the Seller gets a clean exit from the deal. It also makes contract negotiations much quicker and smoother.

The policyholder in these cases is the Buyer.

This Isn’t Your Grandfather’s Insurance Policy

It’s sad, but not surprising that people only learn what they’re covered for AFTER they suffer a loss. Unlike regular insurance, R&W policies undergo a thorough review of an eligible M&A transaction before coverage is offered. This pre-placement collaboration between the policyholder and R&W Underwriters eliminates much of the guesswork when a claim is reported.

The first step in putting together any R&W policy is giving Underwriters (virtually all of whom are former M&A attorneys themselves) access to the data room and the Buyers’ diligence materials. R&W Underwriters don’t “reinvent the wheel” and perform their own diligence, they simply review the Buyers’ diligence of the Sellers’ reps.

The process begins with a conference call between Underwriters, and the policyholder’s deal team and their attorneys. A discussion of the terms of the deal, and any questions arising from a review of the diligence are addressed. At the end of the call, both sides have clarity as to which reps will be fully covered, which reps will be excluded (if any) and if any other limitations or restrictions are applied. Keep in mind, this is all done before anything “bad” ever happens.

The call is followed by the issuance of a valid R&W policy that reflects the issues and agreements reached in the call.

What happens if there’s an issue after the deal goes through?

Claims are very rare in this niche – only 15% to 18% of policies have claims reported. But if you do have to file a claim, you’re looking good with this coverage, even better if you follow certain steps.

With Rep and Warranty coverage, the more you help the insurance company process your claim…

  • The more likely a claim will be paid
  • The more money you’ll receive
  • And the faster you’ll be paid

It goes without saying that working with an insurance company is much better than trying to go after a seller directly to get damages through a lawsuit – that would be a long drawn out fight, expensive and time-consuming.

Why You Need to Be Your Insurance Company’s Best Friend

Here’s how the process of filing a claim works on a basic level.

It’s very easy to file a claim, and the response to your initial contact is within 48 hours. The insurer will ask you to tell them the story of what happened, why you think it’s a breach and the resulting financial loss.

That last part is why it pays to go above and beyond with the information you provide to the insurer holding your Rep and Warranty coverage: the underwriters don’t know the details of your business or your industry as well as you do, so they rely on your expertise.

They did enough research during the initial underwriting phase of putting together your policy to understand the risks involved – based on the due diligence you provided. But to actually calculate damages and compensation takes much more detail.

You hold the keys now, so you have the information on the damages you’ve suffered.

Before making a payment, the underwriting attorneys need to confirm a breach happened and determine if the Buyer/policyholder was harmed and to what degree. They need to understand your business to make that calculation.

Say a business purchases a manufacturer in the auto parts industry and a few months down the road the main supplier unexpectedly boosts their prices from $2 per unit to $2.50. That’s a huge jump that will impact revenues and profits.

But being unfamiliar with the auto industry, the Underwriter needs help determining the extent of that impact.

In another hypothetical scenario, let’s say a restaurant chain is purchased. But several months before the deal went through, the chain had a promotion and gave out $1 million in gift cards. They simply forgot to declare the unclaimed gift cards when doing the deal. It was an oversight that’s covered by R&W insurance.

But again, an Underwriter unfamiliar with the restaurant industry needs help determining the liability resulting from those gift cards.

The best course of action for these businesses is to open up their books to show how significant that price increase or those unredeemed gift cards will impact the company’s bottom-line. And not just that.

When the Underwriters ask questions or request more information or clarification, provide it as soon as possible. This process should feature open communication and a spirit of working together. No suspicion.

Do that, and your claims payment should get to you within weeks.

Open Communication Is a Good Thing

The number one goal of Underwriters examining claims with your R&W coverage is to “get it right” – to pay out the correct amount – no more, no less – to you as a policyholder.

To do that, they need to understand, by the numbers, the damage you suffered. No business, let alone an insurance company, will write a blank check.

They’re not going to nickel-and-dime you. And they won’t deny a claim outright except under very specific circumstances.

Often the denied claims that we see in the industry were filed even when the policyholder knew they would be denied or already had been excluded from the policy.

It might be a breach of the sales agreement that the Buyer knew about before the deal went through and had been disclosed by the Seller in advance.

Or, it could have been a sexual harassment or wrongful termination lawsuit that was on the horizon but wasn’t filed until the new owners took over… or an environmental contamination issue that was ongoing during negotiation, although the full extent only became known later.

The company filed the claim simply to have the issue on record even though it wouldn’t be covered.

For Peace of Mind – Get Rep and Warranty Coverage

When it comes to post-M&A claims, the difference in experience between an insured deal and an uninsured deal is like night and day.

If the deal is insured, the process is so much smoother and less emotional.

Without a policy, the Buyer accuses the Seller of breaching the contract. The Seller is defensive, the Buyer is angry. There is a lot of tension.

If the deal is insured, all that emotion is gone. Because the insurance carrier is there to pay the claim, it becomes a difference of opinion that can be worked out.

Unlike typical insurance, R&W claims are paid more times than not. And there is no risk in providing all the information you have to the Underwriters. They’re more like partners than antagonists.