Following up on Part One of this blog posted on January 26, 2017, this blog will look at a specific situation where reps and warranties insurance coverage could be useful to both buyer and seller. Let’s assume seller is close to 65 years old and owns a majority of the shares of stock in a high-risk, but profitable, business along with two friends who own the balance of the shares, but have never been active in the business.
The seller and his friends have agreed that this would be an excellent time to sell and enjoy the success that had been created by seller. The buyer has made an offer to purchase the business in a stock transaction for the price of $25 million with half due at closing and the balance represented by a promissory note payable over seven years. The buyer wanted an asset purchase transaction. But it was not possible since valuable contracts could not be assigned. The seller and his friends find the price and payment terms satisfactory. The buyer also makes an attractive proposal for seller to remain as a part-time employee for several years with an attractive salary and benefits package in order to spearhead the transition.
Everything looks good until Seller’s lawyer calls and says he needs to talk to him about some concerns he has about the purchase agreement draft, particularly the 12 page reps and warranties section and the five-page indemnity section, plus some other strings attached like buyer’s right of offset against the promissory note and a cash holdback of $6.25 million for 30 months to cover any claims arising under the indemnity section. Seller’s friends suddenly become alarmed at the strings attached as they know virtually nothing about the actual operations of the business and really are not capable of making any reps and warranties and now need to get their own attorneys. Seller is also concerned because he doesn’t know what the implications would be for him and his post-closing employment package if a problem arose with breach of reps and warranties or covenants. Buyer also becomes concerned when seller tells him there are just too many potential negatives for seller and his friends post-closing.
Buyer’s lawyer mentions that the parties may want to look into obtaining a reps and warranties insurance policy to alleviate some of these concerns. They do. And after negotiating with the carrier and among themselves on the amount of the policy, the length of the policy, the amount of the premium, the deductible amount on the policy and the removal of seller’s friends from the reps and warranties section and any exposure under the indemnity section, buyer, seller and seller’s friends agree to revise the draft of the purchase agreement to remove the buyer’s right of offset provision against the note balance owed to a very moderate amount, to eliminate the cash holdback provision and to remove seller’s friends from making any reps and warranties. The deal closes, and everyone is happy.
Well, in the real world, things may not work so smoothly. But the point is there are methods for dealing with the thorny problems of reps, warranties and indemnities (and maybe even justify a higher purchase price) if your deal is the right size to justify the cost.
Michael W. Margrave
Disclaimer: This blog is for information purposes only. Legal advice is provided only through a formal, written attorney/client agreement