Representations and warranties insurance provides coverage for a breach of the warranties given in a sale purchase agreement. The seller or the buyer can be the insured, however, it is always a breach of the seller’s warranties that are the trigger for coverage. When the seller is insured, it’s referred to as a “sell-side” policy; when the buyer is the insured, it’s a “buy-side” policy.
In my last post, Part 1, I focused on the pros and cons of sell-side policies. In this post, we’ll explore the ins and outs of buy-side policies.
Pros for the Buyer
- Happy Seller
Depending on your motivations, being able to offer a seller the cleanest possible exit may get you the edge in an auction situation. It sends the message that you are willing to find compromise on difficult issues and are solutions-oriented.
- Fraud Coverage
Obviously a seller cannot insure against his own fraudulent behavior. However, with a buy-side policy, fraud of the seller is covered. Although very rare, it provides an extra level of comfort especially when a buyer is expanding into new industries or geographic locations.
- Peaceful Relationships
If the seller is the insured, the buyer has to bring a claim and get compensated, and then the seller must turn to its insurance company to make it whole. This can create a contentious situation with a new management team. With a buy-side policy (depending on escrow), the buyer may be able to bypass the seller entirely.
Cons for the Buyer
The use of reps and warranties insurance often comes with a reduced escrow. While the claims process is smooth in most reps claims, escrow is often considered a simpler option.
Pros for the Seller
- The Cleanest Exit Possible
Even if there is still an element of escrow, this has usually been substantially reduced. In addition, there is the knowledge that the risk has been contained and that the insurance allows the seller to know his money is not going to be called on.
- The Best Chance for a Good Integration
Most often, some or all of senior management are staying on. In the event there is a claim, having to fight with your new boss is extremely stressful. Most sellers care a lot about their business and want to see it continue successfully under new ownership.
Cons for the Seller
- Get What You Are Given
The seller must accept the coverage and the price obtained by the buyer. I mentioned in my last post that any transaction contains a lot of competing interests. Reps and warranties insurance removes some of the contention in negotiating these differing positions.
What to Watch for Whether You Are a Buyer or Seller
Regardless of who ends up being the insured, it’s important that you understand exactly what the policy does and doesn’t cover.
Each policy is handwritten, and gaps can occur if it’s not carefully tailored. Take the time to really understand things like the definition of loss, the exclusions, the insuring clause and how the retention works before committing.