According to U.S. court records, federal bankruptcy filings by businesses rose 33.5% year-over-year in the twelve-month period ending September 30, 2024; in fact, per the S&P Global, U.S. corporate bankruptcy filings hit a 14-year high in 2024.[1] Ongoing post-COVID economic challenges, including persistent inflation, tightened bank lending and higher interest rates that have increased the cost of borrowing, have pushed distressed companies to file for bankruptcy as a restructuring solution.
Buyers of distressed assets have increasingly turned to representations and warranties insurance (“RWI”) to protect them from unknown liabilities. As bankruptcy rates have continued to rise, RWI remains a viable alternative to traditional risk allocation for distressed assets. RWI minimizes transactional and litigation risk, unlocks value and provides a range of protections to parties involved in bankruptcy.
RWI policies benefit both buyers and debtors, especially in the context of Section 363 auctions (named for the relevant section of Chapter 11 of the Bankruptcy Code). Section 363 sales allow acquirors to purchase assets or entire businesses at discounted prices, and they offer buyers protections that are generally unavailable outside of bankruptcy. Most notably, the court supervising the auction will give a “free and clear” order in a Section 363 sale that extinguishes most third-party claims and lien risk vis-à-vis the acquired assets. However, the free and clear order does not eliminate the risk of first-party claims due to a breach of a seller’s representations. Those first-party claims can relate to a broad range of liabilities, including product liabilities, compliance with laws, intellectual property, employment matters, environmental exposures and more. However, an RWI policy can mitigate those risks, providing buyers with an added layer of comfort and leading in turn to higher-priced bids for the auctioned assets. Because the value of the assets in a Section 363 sale may be $0, a buyer seeking an RWI policy can use a notional or estimated investment amount to value the assets and set appropriate metrics around the RWI policy limit, associated premium and policy retention (or deductible). RWI therefore provides additional security to buyers and, in turn, drives value for creditors.
RWI policies are also available to cover acquisitions of distressed targets outside the formal bankruptcy context. For example, consider a situation where business owners have breached their financing covenants and have, as a result, turned control of their business over to their lenders. A buyer of that business seeking a market-standard set of representations and warranties in the purchase agreement may be stymied by sellers uninterested in standing behind a business they no longer control (and may not be making any money from the sale of) and a lender unfamiliar with the daily operations of the entity or assets and similarly unwilling to backstop any representations and warranties. In this scenario, RWI can be a critical transaction tool: the sellers and lender, knowing they can walk away from the deal without any liabilities, will be more comfortable providing a standard suite of representations and warranties, while the buyer has the financial backstop of the RWI policy to rely on in making the acquisition. RWI can turn a difficult negotiation into a win-win situation and enable both sides of the transaction to get the best possible bargain.
RWI insurers and underwriters have continued to shift and expand their appetites in response to a changing and challenging M&A environment. Expanded coverage of distressed assets is one of those expansions, and we expect continued flexibility and innovation from insurers as new carriers enter the market. RWI carriers will continue responding to the macroeconomic environment impacting businesses and business owners and creating new opportunities for savvy private equity and strategic buyers.
WTW hopes you found the general information provided in this publication informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, WTW offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).