M&A Minute: When R&W Insurance Works to Cover Interim Breaches

Reps and warranties insurance (RWI) ensures the policyholder is covered for breach of contract for mergers and acquisition (M&A) transactions. Failures in diligence or fraud on the part of the seller can result in breaches of the representations and warranties after an acquisition, whether intentional or unintentional, resulting in potential exposures for buyer and seller. RWI gets triggered when any of the seller's representations or warranties given in a purchasing agreement prove to be incorrect, resulting in a loss to the buyer. There are two scenarios during the sale of the company when reps and warranties insurance are at play.

Simultaneous Sign-and-Close Transactions

One scenario is signing and closing the transaction simultaneously and binding the reps and warranties insurance at closing. It's less common than a split sign and close, but not uncommon. The policy coverage usually lasts three years for general representations and six years for fundamental representations. It's triggered by breach of warranties post-close, and it starts when the deal closes.

Covering the Gaps Between Signing and Closing

The other scenario in an M&A deal is a little more complex. When you have a gap between signing and closing, this could be as little as a week, or it could be over a year long. In this situation, your reps and warranties insurance can provide some interim coverage for this gap between sign and close. Today, the reps and warranties insurance market allows for up to four months of this interim coverage at no additional cost. But if the period between signing and closing goes longer, you can expect to pay an additional premium for every month after.

The coverage for this gap between signing and closing is what we would consider partial. For example:

1. If a breach occurs prior to signing and is discovered between signing and closing that will be covered.
2. If a breach occurs between signing and closing and is discovered after the close, that will be covered.
3. If a breach occurs between signing and closing and is also discovered between signing and closing, that will not be covered.

The partial coverage aspects make some buyers nervous because this is not a gap found in traditional indemnification in a sale and purchase agreement.

In terms of risk profile, there is a big difference between a week's gap and a year's gap from sign to close. However, every deal is different. For example, if you're looking at a tech deal, in which most of the value is IP, it would not be likely to see a piece of code that is both created and discovered in the period between sign and close. In this case, the breach could likely be tied to a piece of code created prior to signing, which would fall under interim breach coverage. However, the most likely scenario for a breach to both occur and be discovered between sign and close is a cyber breach. Having said that, in this particular example, it would be very helpful if the target had cyber insurance in place to cover that loss. And that's another reason that with reps and warranties insurance, due diligence is such an important part of the process.