2024-11-08 07:09:00
Legal affairs news channel
There has been much discussion about the role of representations and warranties (“D&Gs”), their function in contracts for the sale of shares/assets and the liability arising from their inaccuracy or falsity. Basically, D&Gs are tools in M&A transactions used to manage and allocate risks. In this way, whoever makes a statement assumes the risk that the facts or state declared regarding a company or the individual himself are not truthful.
As a rule, falsity or inaccuracy can lead to breach of contract and damage to the buyer. The mechanism commonly adopted to ensure that the buyer is compensated for the losses caused involves the withholding of a part of the price, by the buyer (holdback) or by third parties (escrow). The first requires the buyer to retain part of the price for a certain period. The second, the establishment of an escrow account where the buyer deposits a part of the price, which is held by an agent for a period of time, the disbursement of which involves the occurrence of certain events and the sending of an instruction.
However, the use of warranty and indemnity insurance (W&II) has increased as a coverage mechanism for parties. This mechanism is mainly offered with three types of products:
1. Warranty and indemnity insurance: aims to protect the parties from a loss resulting from non-compliance or misrepresentation in the D&G. In this way the risk is transferred from the defaulting party to a specialized third party, or insurer;
2. Insurance covering tax/tax risk: aims to reduce or eliminate exposure to a tax risk following a complaint or audit by tax authorities, regarding the tax treatment applied to a transaction. This insurance aims to transfer tax risk from the taxpayer to the insurer; AND
3. Litigation and potential risk insurance: aims to cover and compensate: (i) losses caused by damages and losses faced by the defense of a company due to an active lawsuit or possible litigation (adverse judgment insurance), or (ii) a favorable outcome insurance in the first instance when an appeal is unfavorable to the initially successful party in a trial (preservation of the sentence).
This is how insurance companies (or underwriters) have sought to delve into the mergers and acquisitions market by offering a service that adapts to the needs and preferences of the parties. Although in Colombia this mechanism was adopted in only 8% of transactions, in Europe the trend rose to 16%, a figure analyzed thanks to the annual studies developed by the CMS global network (CMS European M&A Study 2024).
On the one hand, the proactivity of insurance companies in making themselves known and making the parties involved in these operations aware of the advantages they can offer for the distribution of risks will be decisive. On the other hand, this alternative presents itself as an opportunity for parties and their advisors to: encourage the disclosure of transparent and sufficient information; structure more attractive contracts in competitive transactions; close transactions that in principle can be hindered by deal breakers and protect commercial and even personal relationships, post-closing.
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Interview: The Role of Representations, Warranties, and Insurance in M&A Transactions
Time.news Editor: Good morning, and welcome to our segment on legal affairs! Today, I have the pleasure of speaking with [Expert’s Name], an authority in corporate law and mergers and acquisitions. We’ll be diving into the nuances of representations and warranties in M&A transactions. Thank you for joining us, [Expert’s Name].
Expert: Good morning! Thank you for having me. It’s a pleasure to discuss these critical aspects of M&A.
Editor: Let’s get right into it. Could you explain the concept of representations and warranties — often referred to as D&Gs — and their significance in M&A contracts?
Expert: Absolutely! Representations and warranties are essential components of M&A agreements. They serve as assurances from the seller to the buyer regarding certain facts about the business being sold. Basically, these statements relate to the condition of the company, its assets, and any potential liabilities. If these assertions turn out to be false or misleading, they can lead to significant liabilities for the seller, as they bear the risk of those inaccuracies.
Editor: So, if a representation or warranty is found to be incorrect, how do buyers typically protect themselves against potential losses?
Expert: Buyers usually include mechanisms in the contract to safeguard their interests. One common approach is withholding a part of the purchase price, known as a holdback, for a certain duration. Alternatively, they may utilize an escrow arrangement, where a portion of the funds is held by a third party. This retained amount can then be used to compensate for any potential breaches or misrepresentations.
Editor: That sounds like a prudent approach. However, I’ve heard there’s been a notable shift towards warranty and indemnity insurance (W&II) in recent years. What’s driving this trend?
Expert: Great observation! The uptick in W&II can largely be attributed to the increasing complexity of transactions and the associated risks. These insurance products provide an additional layer of protection. For instance, if a seller fails to comply with their D&Gs, the insurance can cover the losses without draining the seller’s resources. This shift not only offers peace of mind for buyers but also allows sellers to negotiate better terms since their exposure to risk is mitigated.
Editor: You mentioned different types of W&II products. Could you briefly outline them?
Expert: Certainly! The main types include:
- Warranty and Indemnity Insurance: This protects against losses stemming from non-compliance or misrepresentations in D&Gs, effectively transferring risk from the defaulting party to the insurer.
- Tax Risk Insurance: This is specifically designed to address concerns about potential tax liabilities following audits or disputes with tax authorities regarding the treatment of a transaction.
These products cater to various concerns that can arise in M&A, making them invaluable in modern deals.
Editor: It’s intriguing how these instruments create a safety net for both parties involved. Are there any potential downsides or challenges associated with using W&II?
Expert: Certainly, while W&II can be beneficial, it’s important to remember that there are costs involved in securing such insurance. Additionally, the underwriting process can be thorough, leading to possible delays in closing transactions. Moreover, obtaining comprehensive coverage may be challenging in highly complex or contentious deals.
Editor: As always, navigating these complexities requires expert insight. Before we wrap up, what advice would you give to companies considering M&A transactions regarding the use of D&Gs and insurance?
Expert: My key advice would be to conduct diligent due diligence and carefully assess the risks involved. Collaborating closely with legal and insurance experts can greatly enhance the understanding of potential liabilities and help craft robust representations and warranties. This proactive approach can ultimately facilitate smoother negotiations and successful transactions.
Editor: Fantastic insights, [Expert’s Name]! Thank you for shedding light on the intricacies of representations and warranties and the evolving landscape of M&A.
Expert: Thank you for having me! It’s been a pleasure to discuss these vital topics.
Editor: And thank you to our audience for tuning in! Stay informed and connected with Time.news for more updates on legal affairs and beyond.