August 18, 2020 Update: Please see our most recent blog, Representation and Warranty Insurance 2020 Update, for a summary of two recent market reports that provide helpful information to buyers are using representation and warranty insurance.
Due in large part to greater awareness of the strategic value of representation and warranty insurance (RWI), an increasingly competitive underwriting market in Canada (resulting in lower costs, lower deductibles and more favorable policy terms) and a very competitive, vendor-friendly M&A market, we have seen RWI continue to grow in prevalence in Canadian deal-making. The more frequent use of RWI illustrates the maturing RWI market in Canada and the upside it provides in various transaction situations. Whether targeting improved indemnity protection or longer survival periods, improving a bid in a competitive auction process, or opting for a RWI policy when no vendor indemnity is possible (or desirable), there are various ways RWI can provide comfort to both vendors and purchasers.
RWI protects against unanticipated and unknown breaches of representations and warranties. In its most basic form, RWI can take the place of or supplement indemnity provisions and survival periods in a transaction. Coverage is available for both fundamental and non-fundamental representations and warranties as well as for specific representations and warranties where appropriate. Where there is a mismatch in the comfort level or risk tolerance between the vendor and purchaser, the parties can resort to RWI to get the deal closed.
RWI can be used in a number of situations including:
RWI does not replace due diligence since insurers piggyback on the due diligence conducted by parties in order to assess the risks associated with any given deal. The same applies to negotiating the underlying agreement, and in particular, the representations and warranties the insurance will be covering. Through the underwriting process, insurers verify that the purchaser has conducted thorough and comprehensive due diligence and that the parties have extensively negotiated the purchase and sale agreement on market terms.
As RWI policies are bespoke and customizable based on numerous factors, they require a lot of care and attention in drafting. The definitions of breach, covered costs and loss are critical to ensure that the appropriate coverage is included. Additional issues for negotiation include the definition of knowledge, coverage amounts, term, retention (or deductible), retention drop-down and total insurance coverage costs (including premiums, underwriting fees and broker fees). In addition, purchasers should give special attention to the interaction between the provisions of the purchase and sale agreement and the insurance policy terms with respect to the treatment and availability of such things as consequential damages (including lost profits and diminution in value), materiality scrapes, pre-closing period tax indemnities and coverage for fraud perpetrated against the insured. As coverage is typically effective at closing, any risks associated with the interim period between signing and closing will not be covered unless expressly contemplated in the policy language. The final result should be a policy that fulfills both the risk and cost requirements of the parties.