R&W Insurance: What to Know About Sell-Side Policies

For context, roughly 98% of RWI policies that are placed in conjunction with a mergers & acquisitions (M&A) transaction are buy-side—meaning the buyer is the “named insured” and would reap the benefits of the policy should any covered breach of the reps & warranties arise, regardless of which party is paying for it. Buy-side policies benefit both parties in a transaction (which is why we often see the costs split between them) and generally offer more fulsome coverage to an insured. Hence, we almost always recommend proceeding with a buy-side policy when it’s an option. But, in instances where sellers want the coverage and buyers don’t, sell-side policies can still provide protection from unknown breaches after a deal closes.

As a seller, you may find yourself in a situation where the buyer refuses to place a policy. We’ll discuss a few things you should know when considering a sell-side policy.

Market Participation

Today, the number of active insurers in the US RWI market is just shy of 30. When a buy-side submission is sent, we often receive as many as 10 to 15 non-binding indication letters (NBILs) to choose from.

On the flip side, only about half the market offers a sell-side product. This means, deal specifics aside, the pool of potential insurers is smaller, and their risk appetites for sell-side policies tend to be narrower. For example, most (pretty much all) the insurers that will underwrite sell-side policies require audited financials. In addition, the size of the deal plays a heavier role in market participation than on the buyer side. Underwriters are far more reluctant to underwrite smaller sell-side policies than buy-side policies, and they may even be more selective about which industries they would be willing to cover.

How Claims Work

Like buy-side policies (or any insurance policy, for that matter), sell-side policies are triggered once the insured suffers a loss. R&W policies cover unknown breaches of the seller’s reps in the purchase agreement; thus, it backstops the reps and warranties provided by the seller to the buyer within that agreement.

Though the seller is the insured here, the seller remains liable to the buyer for breaches of the purchase agreement, and the R&W policy will, in effect, reimburse the insured (seller) for any loss suffered. In this case, the buyer would advise the seller of a breach of a rep or warranty in the purchase agreement. Under a sell-side policy, the buyer is considered an indemnitee. Whether the claim arose from a third-party action promulgated against the buyer, or the buyer itself discovered a breach, the buyer would notify the seller of the issue and point to the rep or warranty that was allegedly breached. The seller would then provide notice to the carrier of the claim.

Assuming the claim is covered under the policy and is ultimately resolved by the indemnitees, the seller would pay the buyer for the loss it suffered from the seller’s breach of the reps and be indemnified by the policy. The seller is responsible for providing the insurer with information about the claim so that the insurer can determine whether the claim is covered.

It is worth noting that some policies require the seller to actually pay the loss and then be reimbursed, while others allow for “pay on behalf” language, which means the insurer will pay the buyer directly once a covered claim has been determined. We strongly recommend involving the insurer as early and as often as possible during the course of the claim.

Indemnification Restrictions

Buy-side policies became popular partly because they offer coverage enhancements and extended survival periods of the reps, beyond what is outlined in the indemnification section of the purchase agreement. For example, a typical buy-side policy will cover the general reps for three years and the fundamentals for six, despite a typical survival of the reps in the agreement of 12 to 18 months. While not as common, buy-side policies can also provide limits (up to the purchase price in some instances) that are higher than the seller’s obligations in the agreement.

Not the case with sell-side policies, which need to be exactly aligned with the indemnification section. Insurers can’t insure more than what sellers are liable to pay in the terms of the purchase agreement. As previously discussed, the sell-side policy will only trigger once the insured has suffered a loss. Since buyers can’t bring a claim beyond a seller’s obligations, the policy will follow suit. The sell-side limit will be equal to the escrow amount, and the policy period will terminate simultaneously with the survival of the reps in the agreement.

Note that all sell-side RWI policies will come with an exclusion for seller fraud.

Underwriting/Diligence

Sellers don’t typically have diligence reports prepared as a buyer would, which leads to a different underwriting process. Instead of asking, “How did you get comfortable with the reps the sellers made?” underwriters will ask, “How did you get comfortable making these reps to the buyers?” 

Underwriters will request a diligence tracker and spend a lot more time in the data room than they would underwriting a buy-side policy, focusing on the seller’s internal process. Also, the diligence calls can last longer than a standard buy-side call since underwriters will need to talk through the issues without the guidance of a diligence report. Consequently, diligence fees tend to be higher for sell-side policies—not materially higher, but noticeably.

Final Thoughts

We don’t intend to discourage companies from purchasing sell-side RWI policies. They offer the same protections against unknown breaches as their counterparts, just with certain limitations that we felt were worth mentioning. As previously noted, we will usually recommend a buy-side policy that benefits both parties when that is an option. Reach out to our team to discuss the differences between buy-side and sell-side RWI policies or if you have any RWI questions.