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M&A Insurance Helps Bidders Stand Out In Packed Market

In a marketplace crowded with suitors vying for relatively few assets up for sale, wannabe buyers can sweeten their offers by integrating insurance that protects sellers from potentially costly representation and warranties risks — a move that can give bids a distinct leg up in competitive auctions, experts say.

Particularly as assets available for private equity purchase dry up, reps and warranties coverage — still relatively new on the scene — has taken a firmer hold. With more buyers circling fewer targets, squeezed bidders are under pressure to get creative and distinguish themselves in order to prevail.

"I've had people — clients, bankers and other parties — reach out to me because they're dealing with a competitive process and thinking through how they might strategically think about the use of representations and warranties insurance," Hamed Meshki, a Kirkland & Ellis LLP corporate partner, said.

The coverage insulates buyers or sellers from losses incurred post-closing tied to a seller's false representations or warranties. The policies can cover financial statements, litigation and tax information, among other things. The policies also allow sellers to avoid locking down a portion of a given deal's proceeds in escrow to cover potential future claims, guaranteeing quicker and heftier payouts.

In addition, the insurance carries an appeal to buyers with its bigger window for claims recovery. The standard term generally lasts between 12 and 18 months, but the coverage commonly extends that period to three years or longer, providing buyers more flexibility.

But it's the instant gratification that makes reps and warranties policies an enticing prospect for private equity sellers. By skirting traditional escrow requirements, the firms can redistribute bigger gains more quickly, answering pressure to beef up investor returns and redeploy funds.

"Even assuming 12 months go by and the seller gets all its escrow funds returned, the seller is still not in the same place that it would have been with a bidder that used reps and warranties insurance," said Kirkland's Jeremy Liss, who focuses on private equity. "It not only gives a seller certainty, but it also effectively gives them more proceeds by allowing them to invest the funds that otherwise would have been escrowed at a higher rate of return."

Although some suitors adopt the coverage as a competitive tool from the beginning, more reactive players turn to the insurance in an effort to outmatch offers already set forth by rival bidders. When one similarly priced offer includes coverage that caps the seller's indemnity at a relatively low rate — for example, between 1 and 3 percent — it forces other wannabe buyers to beat, or at least match, the proposal.

Beyond lightening a seller's potential indemnity burden, the introduction of reps and warranties insurance can spur other benefits that pile onto a given bid's appeal — pivotal considerations in highly competitive auctions where every advantage counts.

"When the indemnity piece is off the table, that can really streamline the negotiations and sellers can internalize that as helping to get them to a quick close," Meshki said. "And particularly where you've got a buyer or buyer's legal counsel who's experienced with the product, that helps to establish and build their credibility."

The policies have also stepped into focus as a way that sellers can dodge an unwelcome tactic for buyers to recoup a portion of a deal's proceeds by filing erroneous reps and warranties claims, said Gabor Garai, who leads the private equity and venture capital practice at Foley & Lardner LLP.

Some buyers have filed such claims on the belief that sellers would rather resolve the dispute by giving up some money in a settlement rather than heading into expensive court proceedings, he said.

"If you have reps and warranties insurance, the sellers can feel more comfortable that they're not exposed to that contingency," Garai said. "They don't have to wait 18 months to know that all of the purchase price is safe, or whether some of it is still exposed to potential claims."

As they become more familiar with the policies, sellers in some cases have asked buyers to take on policies from the outset as a condition of lobbing a bid. The move ensures indemnity protections and looser escrow requirements, but can invite other risks for the seller — especially as the coverage itself remains on the back burner for a wide swath of the market players.

The mandated inclusion of a reps and warranties policy could push bidders to resist shouldering its cost when it was the seller that required the coverage in the first place, Meshki said. Questions over the costs of coverage — tabulated based on each transaction — can also play into bigger doubts over whether the assets trading hands pose real indemnity risks in the first place.

"There's a psychological element to this that buyers and sellers both need to be aware of," he said.

On the flip side, sellers can also use reps and warranties insurance to appeal to certain bidders and maximize the value of the holdings they're trying to unload. By adding coverage to the mix, sellers can insulate buyers from losses incurred post-closing — a benefit that takes on added significance in cross-border negotiations.

The framework for resolving reps and warranties disputes, and addressing concerns in deal agreements, varies by locale. Differences can put a barrier between a seller and its desired buyer, which might have concerns over whether any post-closing claims would force it to litigate in an unfamiliar jurisdiction with murkier standards, Garai said.

"The seller, by having a sell-side policy, can enhance the value of the asset it wants to sell by minimizing the perceived risk that a U.S. buyer or other foreign buyer might feel exists," Garai said. "Basically what it does is it levels the playing field to the point that the foreign seller looks more like an American seller would, in terms of the risk profile."

Even against the backdrop of the rising popularity of reps and warranties coverage and more awareness of its strategic uses, it's still a minor factor compared to other considerations — namely, price. Still, especially in hotly contested pursuits where well-matched bidders square off, the insurance can pay off in a big way.

"Of course, the number one thing that each seller is looking for is price," Liss said. "But where you end up with several bidders at essentially the same price and one party is offering minimal exposure … it makes the bidder using reps and warranties insurance have a more attractive bid."