Insurance Coverage for Seller Reps & Warranties in Business Purchase/Sale Transactions - Part 1

Insurance Coverage for Seller Reps & Warranties in Business Purchase/Sale Transactions – Part 1

In a business sale transaction, whether it be in the form of an asset sale, a stock sale or a merger, two of the key areas of contention between the parties involve the negotiation of the Seller Representations and Warranties Section and the Seller Indemnification Section of the purchase/sale agreement. These sections really deal with allocating risk between buyer and seller after the transaction closes. Countless hours can be spent haggling over the language in those sections. And sometimes, the inability to reach common ground causes the deal to collapse.

The purpose of this blog and a follow-up blog or two is to point out an alternative approach to dealing with these transactional issues pertaining to seller representation and warranties. About fifteen years ago, major insurance companies came out with representations and warranties coverage policies that enable the parties to augment or replace in whole or part the traditional indemnification provisions that sometimes can be the major obstacle in closing a deal. But it has only been in the last four or five years that these policies have seen greater usage in the business community. Now these policies will not be suitable for every deal. There is probably a minimum threshold for these policies to be economically utilized. That number is likely to be a transaction where the coverage sought under the policy is not less than $6 million or so and perhaps bit more. There are many companies that underwrite this coverage. So, your having an insurance agent familiar with this area would be useful for the purpose of surveying the current limit levels required by the providers.

Before underwriting, most companies will likely charge an underwriting fee in addition to premiums. It appears that these underwriting fees can run between $10,000 and $50,000 or more. They are intended to help the insurance company cover its own costs in doing its own due diligence and probably to discourage window shopping for the best deal. The premiums themselves appear to run between 2.0% to 4.0% of the amount policy coverage obtained. Who pays the premium will likely depend on a number of factors, particularly who is benefitting most from the coverage. However, there may be circumstances where both buyer and seller are obtaining benefits so that they decide to split the cost.

Future blogs will deal with other aspects of this coverage. One scenario we will deal with is the closely-held business where the senior owner desires to sell the business and not have to deal with purchase price holdbacks, note offsets and indemnity limits. If the deal is large enough, this insurance may be a way to alleviate or eliminate a lot of post-closing worry.

Michael W. Margrave
mmargrave@mclawfirm.com
480-994-2000

 

Disclaimer: This blog is for information purposes only. Legal advice is provided only through a formal, written attorney/client agreement.