Representation and warranty insurance (RWI) has become the default method by which buyers of private companies obtain protection for losses that arise from breaches of a seller’s representations or warranties in the purchase agreement. The ubiquity of RWI in private M&A – and, increasingly, public M&A – stems not only from its numerous advantages (e.g., facilitating the negotiation of the representations and warranties, simplifying otherwise complicated indemnity provisions, preserving the post-closing relationship between buyer and rolling management, etc.), but also from RWI brokers’ and underwriters’ ability to adapt the product to various alternative transaction structures.
In this article, we examine how RWI can operate to cover both sides of a joint venture or merger-of-equals transaction (which are referred to collectively as JVs below).
When structuring the RWI policy coverage for a JV, typically the best outcomes result from placing separate policies on behalf of each party to the transaction, using a single RWI broker and a single RWI insurer. This approach can result in more favorable pricing, especially for smaller transactions, as insurers are incentivized to provide competitive terms for the privilege of underwriting and receiving premiums for both sides of the transaction.
Engaging a single RWI insurer to underwrite both sides of a JV transaction can also provide comfort to both parties to the transaction that similar risks or issues identified on each side (and subject to similar representations in the purchase agreement) will be treated in similar fashion. This is especially true where the transaction involves the combination of businesses with similar operations and risk profiles. Moreover, using a single RWI insurer is more efficient in terms of both time and legal fees, as the insurer will use the same base policy documentation for each side of the transaction and will usually agree that concessions or enhancements in the policy that one party negotiates are also offered to the other party. This approach helps to mitigate any concerns that one party is receiving preferential terms as compared to the other party.
In a true “merger of equals” transaction, where each shareholder group owns ~50% of the combined entity, RWI coverage under each policy is typically provided on a pro rata basis. Specifically:
For example, if two companies, each with an enterprise value of $250 million, combine to form a $500 million combined entity, then each RWI policy will:
The loss proration construct in this scenario aligns the loss payouts under each policy with the actual economic ownership of the shareholder group that benefits from each policy, preventing one group of shareholders from recovering 100% of a loss when such shareholders only bore 50% of the economic impact of the loss in question due to their 50% ownership in the combined entity.
However, in a “merger of non-equals,” the coverage structure can be more complicated. For example, where one business makes up 70% of the value of the JV and the other business comprises the remaining 30%, the majority shareholders’ policy will provide full loss coverage with respect to the business insured under its policy. On the other side of the transaction, the minority shareholders’ policy will typically follow the market-standard approach for RWI in minority investments. This means:
The parties to a merger of non-equals will likely have divergent views about the appropriate amount of RWI coverage to purchase — the majority shareholders will seek policy limits based on the enterprise value of the 30% business, while the minority shareholders may purchase an amount of coverage based on the investment value in the 70% business. Each JV partner’s decision regarding the exact amount of RWI coverage is ultimately highly fact-specific and can depend on the businesses being contributed to the JV and other commercial considerations.
Although coverage and payout structures in the JV context can complicate an RWI placement, it is your broker’s responsibility to dedicate consideration to such issues in advance of underwriting and ensure a smooth process on both sides of the transaction. WTW’s transactional risk team has experience guiding its clients through successful RWI placements in such transactions, and we look forward to leveraging our expertise to continue to do so in the future.
Need help with your joint venture or merger? Reach out to a WTW transactional risk team colleague or contact us here today.
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).
