One of the greatest contributions members of the American Bar Association make is in pooling their knowledge for the good of all members. Nowhere is this is shown more clearly than in the deal point studies that they produce.
The M&A committee recently produced the Private Target Mergers and Acquisitions Deal Point Study, which for the first time includes statistics on representations and warranties. While one needs to be a member of the ABA business law section and M&A subcommittee to access the full study, it’s worth signing up for this and the other excellent insights the publication provides. The chair of the study has kindly given me permission to reference some of the statistics in this blog.
Use Of Reps And Warranties In M&A Deals Examined
Led by Jessica C Pearlman of K&L Gates in Seattle, the group examined 139 deals involving public companies buying private companies in the $30M-$500M range. They reviewed the deals for a wide range of issues: financial provisions, pervasive qualifiers, reps, warranties and covenants, closing conditions, indemnification provisions, dispute resolution and the use of reps and warranties insurance.
Obviously, there are limitations to the study. Only public companies of a certain size will publicly reveal the terms and conditions in deals they engage in, so many deals are left unexamined. However, it provides great insight, especially for those of us focused on the middle market.
So What Did They Find?
In the study, 29% of deals specifically referenced the use of Representation and Warranties insurance. While this means 71% did not make reference to it, it is likely at least a few of them will also have made use of either reps and warranties or another transactional insurance product. Even if we put that aside, the fact remains that nearly 30% of deals examined utilized this insurance. Just four years ago it probably wouldn’t have been a statistically relevant figure. For me, this speaks not only to the increased understanding of the product, but also that it is genuinely serving a purpose.
Bound At Signing Or Closing?
Reps and warranties insurance can be bound either at signing or closing. If you bind at signing, it provides some coverage for the period between sign and close (coverage for any breach that occurred prior to signing but is discovered between sign and close). If you bind at closing, you are only covered from that period forward. The team found that the reps and warranties insurance was expressly bound at signing 48% of the time, which is less than I would have imagined. In my mind, there is no reason not to bind at signing unless it is a question of time or simultaneous sign and close. The downside to incepting at signing is that one does have the potential to lose 10% of the premium (which is paid in deposit at signing if the policy is incepting then) if the deal does not close.
Is The Insurance The Sole Source Of Recovery?
One of the reasons for using representations and warranties insurance is the facilitation of a clean exit for the seller and the ability of the buyer to bring a claim without suing his/her management team. So how often is an exit from an M&A deal that clean? The study expressly spelled out that representations and warranties were not the sole source of recovery only 20% of the time. In 18% of the cases it was the sole source, but only for non-fundamental representations. Reps and warranties were explicitly the sole source of recovery 23% of the time. This tells us that reps and warranties insurance has wider applications than facilitating a clean exit, which is not surprising. We’ve seen a growth in its use purely for ease of negotiation and best practices, or to make a seller more comfortable.
The deal point study has a wealth of information beyond reps and warranties and answers the kinds of questions our clients ask us most often.
I hope that the Deal Point Study continues to include these statistics. I’d love to see even more categories added to the representations section.