Representation and Warranty Insurance? Capital Is Better Spent on Due Diligence

Over the past several decades here at Calkins Law Firm we have assisted our clients through hundreds of mergers and acquisitions. And as is now the norm, representation and warranty insurance (RWI) were a key part of the process. These policies can cost untold thousands of dollars for buyers and sellers alike. Despite their ubiquitous nature, we've come to hold the unpopular opinion that representation and warranty policies aren't worth the investment.

Representation and warranty insurance protects buyers from damages and loss resulting from a seller's inaccurate representation of their company and any promises or claims that those statements are true. Prior to this now common practice, an escrow account was created to hold back part of the purchase price to account for any sustained losses. The seller and buyer would come to a mutual reimbursement agreement should a breach of warranty or representation occur post-closing. If nothing was discovered after a set time period (often 1-2 years) then the sum in escrow would be paid to the seller to complete the purchase price.

We are legal professionals who are well-acquainted with mergers and acquisitions and so we know full well why RWI is touted as the better option: it negates the need for a hold back or escrow, allowing the seller to receive their full payment and securing the seller's indemnification payment obligation without the traditional waiting period. But putting all that legal jargon aside, the reality is that in those hundreds of acquisitions we've had a hand in, there were only a spare few cases in which a post-closing claim arose. The ultimate cause? Sloppy acquisition due diligence by the opposing party.

Getting Your Due

We've written before about the importance of practical and effective due diligence--this is yet another instance where it is absolutely vital. Experience has borne out time and again that focused, comprehensive acquisition due diligence done prior to a sale matters far more than a pricey policy that allows for a party to raise a claim afterward.

This is especially true since due diligence is already a big part of qualifying for and carrying a RWI policy. Underwriters could want to know about the background of the deal and specific financial details. They'll likely want to learn about any potential restructuring, conflicts of interest, and whether there are any operational considerations that could pose excessive risk in the future.

A key difference between this style of investigation and the work we do on behalf of our clients is that the underwriters are generally not experts in any field other than insurance. So they depend fully on buyers to provide context and give clarification about specific risks the deal could present. Clearly, this is anything but efficient.

But the real point is that due diligence is being done anyway, so why not make it as thorough as possible? Instead of spending tens or hundreds of thousands of dollars on a policy that likely won't be claimed on, we'd recommend putting ample effort, time, and investments into a thorough due diligence investigation by a legal team that is familiar with your industry and who will focus on what really matters.

Legal Expertise and Real-Life Experience

At Calkins Law Firm we continue to watch the increasing popularity of representation and warranty insurance with interest. But given how rare it is that a buyer has a claim post-deal, and after weighing the pros and cons, we are still inclined to recommend a dogged attention to acquisition due diligence. If i's are properly dotted and t's adequately crossed it holds true time and again that representation and warranty insurance is simply unnecessary.

Here at Calkins Law Firm our team has a varied background that complements their legal know-how. Together we can advise you effectively on mergers and acquisitions in a variety of industries. We're proud to offer high-quality, in-depth service to every client we serve. If you want to work with a legal team that understands the unmistakable value of due diligence, look no further. Reach out today to learn more about us and the legal help we offer.