Indemnity and R&W Insurance – Negotiation Impacts and Key First-Time Considerations

[MUSIC] Welcome back to part two of our podcast series on Reppin' Warranty Insurance. Join me today is Riley Deerdin, partner and Calgary Lead of the M&A Group, with extensive experience advising companies and private equity funds on a wide range of transactions. In addition, since corporate transactions can involve cross-practice collaboration, I have the pleasure to be joined by Derek Lewinsky, partner in Denton's corporate group and insurance practice, with a significant emphasis on cross-border mergers and acquisitions and commercial transactions. Let's dive right in and get into it, fellas. So can the two of you provide a bit of color on how putting Reppin' Warranty policy in place impacts the negotiation of the purchase agreement? As an example, our seller parties typically less fussed about negotiating the rep package given that they have coverage from the Reppin' Warranty policy in the event of a breach. And also, how does an insurer get comfortable with the negotiated suite of reps? Yeah, I'll take that one, Danny. I think your comments are completely accurate. Usually, in my experience, when Reppin' Warranty insurance is involved in a deal, it does bring the temperature down when the parties are negotiating the reps and warranties and then them to deeper missions in the agreement. And it does also impact the drafting of these sections of the agreement in ways that, you know, may seem odd to M&A lawyers that are as familiar with the product, that, you know, as lawyers, we need to ensure that the policy aligns with the drafting of the agreement. And we need to be familiar with how insurance will operate and how Hayotes and claims are made to ensure that that's accurately captured in the indemnity provisions. Right. If sellers have sufficient leverage, you know, they'll probably insist buyers look solely to the Reppin' Warranty insurance instead of traditional indemnification from the sellers. So in this case, you know, the haggling over materiality provisions and knowledge, qualifiers, and, you know, how broad a particular rep is. A lot of that can really go away if we're able to look solely to be the Reppin' Warranty insurance policy for any breaches of these, these Reppin' Warranties. And then if the, if a Reppin' Warranty insurance policy truly replaces the sellers in demnity entirely, the buyers will really use to be careful whether they should consider whether the sellers, Reppin' Warranties, survive closing early at all. It's also critical to review all of these definition of loss and claim and other defined terms that they have in there to make sure that they're not adopting definitions that are different from what we're looking at when drafting the contract itself. So, you know, all this to say, there is a lot of consideration that goes into drafting the agreement when a Reppin' Warranty policy is in place that may not be as relevant when there is not a Reppin' Warranty policy in place. Yeah, I'm sure that it's a bit of a different experience for folks that, you know, may do a lot of transactions generally, but don't do a lot with Reppin' Warranty insurance, because I'm sure the agreement is going to look a little bit different and the process is going to be a little bit different. Rather, before we move on to Derek, anything else you want to add on this point? Yeah, I think on this point, like, likewise, you know, it's what I was saying. Well, careful drafting of the agreements to ensure aligns with policy. You have to make sure that we don't have any gaps in the coverage as from what we have in the policy to what we may have in the Reppin' Warranty's. We know we're standing, we have a Reppin' Warranty insurance policy in place. It doesn't mean, you know, we should be accepting broad and qualified reps in the agreements, because there are situations where we'd be at the trouble if there's a gap. Got it. Derek, any thoughts on your end? Yeah, I'll just kind of return to what I was alluding to at the outset of the call, not being that, you know, not dismissing the benefits that go along with a Reppin' Warranty insurance policy, because indeed there are benefits such as, you know, cost savings with respect to negotiation, legal fees, not as much protracted negotiation regarding the reps themselves and demnity provisions, but it all depends on the structure of the deal too. So in some cases, some of those benefits can start to erode if you do kind of have more of a hybrid transaction in which the Reppin' Warranty insurance policy is your first recourse, and then ultimately there still is indemnification rights, whether those be limited to specific known risks or perhaps a smaller basket of representations that maybe aren't subject to coverage under the policy. So it all depends on the factual circumstances, and then just the second thing that just always being careful is council is that, you know, in the end, I think having experience as far as what insurance carriers are actually looking for in the purchase agreement, because there is kind of a style, I don't, styles probably the wrong word, but there is a way that they're going to be reviewing the representations themselves, and in many instances, if the representations themselves are just either too broad, not market, so to speak, there's going to be readouts in the policy. And in some cases, I've seen where, you know, there's just so many readouts due to kind of lack of experience and drafting of the representations. It starts to become kind of a protracted kind of negotiation, because you have one side who's trying to push back against the readouts, and ultimately if the reps themselves were just drafted in a little bit more of an efficient manner, it all could have been avoided. So definitely good to kind of get up to speed with respect to seeing the kind of more common types of reps and language this used. Got it, got it. Yeah, I mean, it certainly sounds like a little bit of experience in the area for council, you know, familiarity with the process would certainly make it more efficient, and ensure that they get all the benefits that they want from the policy. All right, so just moving on. So again, obviously, as I alluded to earlier, you know, it is a it's a different process than a normal transaction. We don't have rep and warranty insurance, and it could be daunting for folks who are or clients who are utilizing the product for the first time. So for someone who may be looking at rep and warranty insurance for the very first time, what are the three main things that you would want them to know and consider? So Derek, you want to you want to lead off on that one? Yeah, sure thing. I'll start with due diligence. I think it's always a surprise, I think for either whether it be council or clients that are going through the rep and warranty process, you know, you're going to have your due diligence that takes place at kind of what I'll call the transaction level. So between the respective parties, so that due diligence is going to take place. But ultimately, the insurance carrier is going to want to get comfort that ultimately, you know, it's not stepping into basically a mind field, and that the risk efficient due diligence done in the target entity and to kind of understand what the possible risk and exposure could be. Because ultimately, then, they're going to want to plan accordingly in the insurance policy. So that then kind of adds a second layer of what I will call a due diligence process that takes place. Now, you know, as is Riley indicated, most of the due diligence reports that are produced during the due diligence phase, the transaction phase, will be shared with the insurance carrier. But normally, then, you're going to get a series of questions that will come from the insurance carrier. Some cases, they can be a little bit seem like they're duplication of what's already been done or asked. And then, a lot of times, there's going to be a due diligence call that takes place with the carrier and then counsel that the carrier has retained to assist the carrier in connection with the underwriting process. So that can add a little bit of time. Now, again, to the credit of insurance carriers, they're pretty efficient and they can usually get the policies done in pretty short order. So I wouldn't say it's a huge time suck, but at least there is, from a legal fee perspective, you are technically then paying for your counsel to then to attend these due diligence calls. So there, there's a little bit more of a cost there and a little bit more work with respect to that aspect. Got it. Riley, in your perspective, three main takeaways or things to consider? Yeah, I think, you know, building on what Derek said and another point you made earlier, one of the most important things I find are these due diligence, the record market processes with the insurance providers, and ensuring that all the parties are in line of what is actually material to the business. As this is going to inform the due diligence process undertaken by the provider and, and eventually it affects the exclusions. I mean, I always remember along the earlier deals I did with Reverend warranty insurance. You know, we got into all of that due diligence call that Derek referenced that we got into about a half hour 45 minutes and back and forth with their intellectual property specialist that they brought onto the call, grilling us all of the due diligence done on intellectual property when there was obviously no intellectual property associated with this company and all. It was not materials of the deal. It really caused an issue on the call and it eventually led to a bunch of exclusions from the policy that didn't really make any sense. So I think you have to understand, and it goes back to drafting the reps appropriately so that they understand what's material, making sure the insurance provider and all the parties understand what's material to the deal. So that you can streamline the process as best as you can and really limit the exclusions and limitations that come in the policy eventually. And on top of that also understanding that there are going to be likely a robust set of exclusions and limitations in the policy. So like you said earlier, Danny, it's not as still capable of it. It's going to couldn't cover everything. I guess one minor point to add on is you make sure it's pretty clear of the agreement who is going to be paying for the policy, who's actually going to be paying the premiums and the retention zone of the policy if the claim is ever made. You want to set the process in the definitive agreement as best you can so that doesn't make any issues down the road if the claim is actually made under the policy. Yeah, definitely no. And those are those are really helpful insights. Thanks very much guys. So Danny, I started to wrap it just I got one because I'd be remiss if I didn't throw this out there because it's always something I always tell clients as well. And it's the last thing you want to say just continue with the due diligence calls is if the carrier is asking about a particular area and they say, well, how did you get comfort with this? And then the answer is, well, we have a representation in the agreement. It's the last thing you want to say. So it's always a quick kind of side tip. If you don't know, you can always just say to the carrier, we'll get back to you. And normally you want to do a little bit more digging or due diligence because the carrier is not just going to want to hear that you're relying on the representations because in the end, that's going to become the carrier's problem. No, that's a helpful insight. And it's always best not to shoot yourself in the foot unintentionally. Yeah, yeah, yeah. No, those are great. So, Raleigh, maybe if we can go back to you here. So now that we've got a few years of data to look at with respect to rep and warranty insurance, are there any trends that you're seeing develop in the market? Yeah, absolutely. We've touched on it already, but with more carriers vying for a smaller market share over the past couple of years, obviously, M&A activity Canada hasn't been as robust as it has historically. So the coverage under rep and warranty insurance policies, rep and warranty insurance policies has become broader to try and capture more market share. And the policy holders are typically seeing more favorable terms in terms of exclusions at premiums as well to try and again, capture more market share on these deals at Canada. In the past, you know, underwriters have tended to reduce the scope of certain reps that most often need to losses or claims for them. But as competition continues to increase among these insurance providers, we're seeing that, you know, these types of reductions in scope have become less and less common. And buyers have been able to negotiate or even reduce Jerusalem. They made these deep deletions as well. Got it. And Derek, how about you with what types of trends are you seeing? Yeah. Everything that Riley indicated, definitely seeing those, especially with respect to the carriers just being a little bit more generous with respect to the absence of exclusions or not as sticky with respect to requests to narrow, but just kind of more of an anecdote. It's more sort of the innovation that we're seeing now with respect to kind of unique coverages and unique products. And just one, I'll just give an example of is there is a transaction that we are working on where ultimately there is going to be an amalgamation of two entities and the two entities who are such that there would not technically be shareholders after the amalgamation, just because of the nature of these entities. And so then the question was, well, if there's an amalgamation that we're doing with this deal with respect to the two factions, you know, if there is a claim, well, who, who recovers? And so there would not be any indemnification provisions. So accordingly, there was thought being given to a weapon warranty insurance policy. And interestingly enough, we're able to find a carrier that offered a policy that essentially would pay out to the new amalgamated entity in the event that there was a loss resulting from one of the target's operations prior to closing. So it was just kind of an innovative way to address that gap. Yeah, very interesting. I mean, I think it sounds like as competition increases and the prevalence of the product increases, just the scope of what you can ensure is similarly increasing. That's correct. Absolutely. Okay. No, guys, that's that's very interesting and very helpful. So, I mean, my sense is that weapon warranty insurance isn't going anywhere. It's only going to become more prevalent. You're going to see it on more deals and just it's going to be more pervasive in the market. With that in mind, are any concluding thoughts that you want to leave our listeners with? I would just say that if you're a deal practitioner or you're someone who's looking to either purchase a business or otherwise sell your interest in a business, I think it is a tool that definitely should be given consideration. Again, it has its place. I agree that it's not going anywhere. And I think it's just going to become more prevalent. So I think it's something to get up to speed on and ultimately, like anything when something's new, I think people are a little reticent. But ultimately, I'm a big fan of the product and I think that it is quite useful in the M&A space. Riley, any parting thoughts on your end? Yeah, those are great comments by Derek. I would say in addition to that, the earlier that you can identify in the deal process that you're going to use weapon warranty insurance or not the better. Obviously, whether you have weapon warranty insurance on the deal and whether you have to go through the whole process of the provider, it's going to have a material impact on your own due diligence process and it is materially going to affect the drafting and negotiating of the rest of the warranties and the deputy sections of the agreement. So, well, it's, you know, obviously not impossible to go back and revise the agreements to put in a written warranty insurance policy or a weapon warranty insurance after the fact. Always better to try and have a buttoned up before you get too deep the negotiations and the drafting process. Because at the end of the day, it's another work stream that, you know, needs to be managed. It's going to take time. It's going to cost money. Going back and doing things over to down for that is never anyone's best interest. So, it's not going anywhere. It's probably going to be used more and more. So, if we are going to use it, probably best to just get them involved and, you know, account for that in the deal flow from the outset. Yeah, I think that's definitely sage advice. So, Jens, that's time for today. So, I just want to say thanks very much Derek and Riley for for joining me today for this interesting discussion. I hope for our listeners that you've pulled out a few useful tidbits. I know there's a lot of good nuggets that I'm taking away from this. So, thanks very much and appreciate your time. Yeah, thanks, gentlemen. Appreciate it. Thanks much. Appreciate it. Dentons is a global legal practice providing client services worldwide through its member firms and affiliates. This episode does not constitute legal or other advice. You should not take or refrain from taking action based on its content. Please contact a legal practitioner to obtain advice with respect to any particular legal matter. Please see Dentons.com for legal notices.