August 30, 2022
With the increase in deal activity worldwide RWI has exploded over the last decade.
According to SRS Acquiom out of the 1900 private deals surveyed in its 2022 report 44% of those deals contained RWI.
Usually for targets with an enterprise value in excess of $20m, RWI is available for deals of smaller values though much less common. It has not traditionally been used when the target is a public company, however this is changing and more public M&A deals are utilizing RWI.
With the increase in the number and size of M&A deals in Israel over the last few years, RWI is now featuring more regularly on the Israeli scene. There are currently several insurers in the market who provide coverage.
The purpose of this update is to provide a brief overview of the principal terms of an RWI policy, the problems it comes to solve and the benefits to buyers and sellers.
Information Imbalance in M&A-Buyer beware
In law school the first thing you are taught is “caveat emptor” – “buyer beware”.
What lies behind this warning is an inherent information imbalance between a buyer and seller. In the case of an acquisition of a company, the seller will always know more about the company being sold than the buyer. This issue drives the many conventions that have come to allocate risk in M&A deals.
The buyer will attempt to redress this imbalance in two ways.
RWI provides an additional option for solving this problem. If the deal contains RWI and there is a breach of a representation covered by the policy, the insurer will pay out the claim to the buyer. Indemnification is a very close cousin to insurance. However, while indemnification shifts risk to the seller for a breach of a representation, rep and warranty insurance shifts the risk to the insurer.
Use of RWI & Key Features
The parties agree on the application and terms of the RWI at the LOI stage. Below you can find some of the key features of RWI.
The elephants in the room
In most discussions regarding the merits of RWI you will encounter two reservations:
Taking the first issue, while there seems to be a lack of independent data on this question, reports produced by some insurers are useful in identifying certain trends. In its 2020 report AON provides the following data:
A more recent report from WTW 2021 analyzing more than 200 claims, provides that 85% of claims were covered within the policy terms, with 15% of payments not covered by insurance. It cites the primary reasons for this as being to the amount claimed not exceeding the policy’s de minimis level and the matter claimed being disclosed during the sale process. The report discloses most claim events as coming from reps relating to tax and financial statement/accounting – with financial statement accounts constituting the highest average claim events. Next in line are the reps relating to commercial/customer, employment and compliance with laws/legal issues.
It’s hard to draw a conclusion from this data. However, overall, based on both reports, the number of claims made was only between 14%-19%. Other than from individual experience it is also difficult to ascertain if the buyer would have fared better by pursuing the seller directly with all of the uncertainty that a contested indemnification claim would involve. You have to assume that a buyer is more likely than not to make a claim if they have RWI than if they were relying on indemnification. That being the case, if affordability is not an issue, there seems to be a compelling case for RWI.
As for “skin in the game”. This is a phrase heard a lot from buyers’ representatives in the course of negotiations on indemnification provisions. Some argue that when a deal includes RWI – since the risk is shifted to a third party (the insurance company) – the seller will be less exacting or forthcoming in its disclosure. Intuitively, this concern makes sense. In practice, however, most sellers will still be incentivized to “do the right thing” – whether that is due to fear of being accused of fraud, the importance of the continuing relationship with the buyer, and (believe it or not) common decency. In Israel, this concern is less relevant, where deals are structured for sellers to still have some skin in the game.
It will be interesting to see the development of RWI market over the next couple of years – with a cooling in valuations and the perception of a buyer’s market. From personal experience, the peace of mind for both buyer and seller (whether perceived or real), and the more streamlined negotiations allow the parties to focus on other (perhaps) more critical commercial terms. I have not come across any cases of a buyer regretting taking out RWI, nor of a seller who would have rather been subject to an escrow holdback!
James Raanan, Adv. is a partner in APM’s Hi-tech and Venture Capital Practice, as well as head of its Telecoms practice. He has over 25 years’ experience as counsel to private and public companies globally, specializing in M&A and complex B2B commercial transactions. He is admitted to the bar in Israel and New York. He can be reached as email@example.com
DISCLAIMER: THE VIEWS AND INFORMATION CONTAINED HEREIN DO NOT CONSTITUTE LEGAL ADVICE.
 There are other tools also at the buyer’s disposal such as deferring payment of consideration in the form of an earnout, but the purpose of this article is to focus on seller’s representations about the company’s history and current state of affairs.
 This list is not exhaustive or applicable in all cases. There will be differences based on jurisdiction, risk profile, the size of the transaction and respective negotiating leverage. The above table is more reflective of terms in US deals.