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By: the Practical Guidance Attorney Team
This article discusses trends in provisions relating to representations and warranties (R&W) insurance in acquisition agreements for transactions announced in the first half of 2020 as compared to transactions announced in the first half of 2019.
THE ITEMS DISCUSSED INCLUDE THE PREVALENCE OF representations and warranties insurance generally, which party pays the policy premium, retention amounts, and the effect of representations and warranty insurance on selected agreement provisions.
R&W insurance is used in M&A transactions to supplement or replace traditional indemnification methods in the event of a breach of the seller’s representations and warranties. Most R&W policies cover breaches of general and fundamental representations and warranties within a purchase agreement (e.g., misstated financials, unknown third-party claims over intellectual property, failure to obtain environmental permits, etc.), which are unknown to the buyer's deal team at the time of execution of the agreement.
The data analyzed in this article was obtained using Market Standards, the searchable database of publicly filed M&A deals from Lexis Practical Guidance that enables users to search, compare, and analyze more than 33,000 transactions using up to 150 detailed deal points to filter search results.1
As one might expect, given the economic uncertainty from the COVID-19 pandemic, deal-flow in the first half of 2020 was down when compared to the same period in 2019. Between January 1, 2019, and June 30, 2019, 1,383 new deals were announced, and between January 1, 2020, and June 30, 2020, 1,053 new deals were announced, a decline of about 24%.
Of all transactions in the first half of 2019, 48 (3.5%) contained reference to a R&W insurance policy. Of all transactions in the first half of 2020, 38 (3.6%) contained reference to a R&W insurance policy. In 2019, insurers underwrote approximately $65 billion of R&W insurance.
Source: Market Standards.2
Breaking these transactions down by target type, in the first half of 2020, 586 private-target transactions were announced. Of these, 29 (5%) included reference to R&W insurance. For the same period in 2019, 37 out of 744 private-target deals (5%) included reference to R&W insurance. Note that these numbers are likely underreporting the total percentage of deals with R&W insurance, as many acquisition agreements may not explicitly reference R&W insurance policies that have been obtained and the terms of many private-target transactions are not publicly disclosed.
As with any insurance policy, a R&W insurance policy requires payment of a premium to purchase the policy. The premium amount depends on the complexity of the transaction and policy and is usually between 2.5% and 4% of the total coverage amount of the policy. This premium is typically paid by the buyer, as the main beneficiary of the policy, but like any other deal term, it is subject to negotiation.
For the 48 transactions in the first half of 2019 that included reference to R&W insurance, 26 agreements included information on which party would pay the premium for the insurance policy. In most transactions (58%) the purchaser paid the entire premium for the policy. In 34% of transactions, the premium cost was split between buyer and seller 50-50 and in 8% of transactions, the seller paid the cost of the policy premium.
In the first half of 2020, the breakdown remained relatively stable, with the buyer paying the policy premium in 63% of deals, the parties splitting the cost in 33% of deals, and the sellers paying in 4%.
Source: Market Standards.
The loss threshold that must be met before a R&W insurance policy may be drawn on (the equivalent of the deductible in other types of insurance) is known as the retention amount.
It is not common for a publicly filed acquisition agreement to state the retention amount for a R&W insurance policy. For the agreements in each period where a retention amount was stated, such amount was typically 1% of the deal value. In the first half of 2019, the minimum disclosed retention amount was 0.75% and the maximum amount was 1.9%. In the first half of 2020, the minimum disclosed retention amount was 0.99% and the maximum amount was 1%.
10b-5/Full Disclosure Representation
Including a 10b-5 and/or Full Disclosure representation in an acquisition agreement can significantly increase the likelihood that the seller may have an unknown breach of representations and warranties. In such a provision, the seller represents that the representations and warranties in the agreement contain no misstatement of material fact and do not omit any material fact necessary to make the statements in the representation not misleading. These representations are becoming less common over time and have been particularly uncommon in deals with R&W insurance, as the present increased risk to the insurer and therefore result in higher policy premiums.
In the first half of 2019, 11% of all deals contained a 10b-5 or Full Disclosure representation. Only 8% of deals that referenced R&W insurance included such a representation.
The first half of 2020 has turned this trend on its head. While 10b-5 and Full Disclosure representations are still very uncommon, they appeared in 5% of deals with R&W insurance. The prevalence of these representations in deals as a whole, however, dropped to just 1.6%.
Transactions with R&W insurance are historically more likely to include a non-reliance clause. In this provision, the buyer acknowledges that it is not entering into the transaction in reliance on any representations made other than those contained in the acquisition agreement.
In the first half of 2019, 8.2% of deals announced included a non-reliance clause. In contrast, 46% of deals with reference to R&W insurance included a non-reliance clause.
This trend held in the first half of 2020, with 7.8% of announced deals including a non-reliance clause. For deals referencing R&W insurance, that percentage increased to 55%.
To find this article in Lexis Practice Advisor, follow this research path:
RESEARCH PATH: Corporate and M&A > Trends and Insights > Market Trends > Practice Notes
For a broad overview of R&W insurance, see
> Representations and Warranties Insurance
RESEARCH PATH: Corporate and M&A > M&A Provisions > Practice Notes
For guidance on drafting provisions related to R&W insurance, see
> Representations and Warranties Insurance Drafting and Counseling Considerations
For information in using R&W insurance as a negotiating tool, see
> Representations and Warranties Insurance Policies Strategic Uses
For examples of indemnification clauses for use in R&W policies, see
> Indemnification Clauses (Representations and Warranties Insurance
RESEARCH PATH: Corporate and M&A > M&A Provisions > Clauses
For a sample R&W covenant clause, see
> Representations and Warranties Insurance Covenant Clause
For a discussion of using insurance coverage as a risk allocation tool during the coronavirus pandemic, see
> Coronavirus (COVID-19): Implications for Representations and Warranties Insurance
RESEARCH PATH: Corporate and M&A > M&A Provisions > Articles
1. For more information on Market Standards, click here. 2. Source: Market Standards. (Current as of 09/17/2020.)