The allocation of risk shapes every acquisition, and the backbone of risk allocation is the right of the acquiring company (the “Buyer”) to be indemnified for breaches of the selling company’s representations and warranties (such selling company, the “Seller”). In a standard acquisition of a non-public Seller, the selling securityholders (the “sellers”) bear the indemnification risk. This risk has traditionally been managed using a two-tiered structure: (i) an escrow funded from proceeds due to the sellers, and (ii) in the event of a claim beyond the escrow, the right of the Buyer to claw back proceeds from the sellers directly. In the 1990s, RWI emerged as a niche tool to shift some or all indemnification risk from the sellers to an insurer. Due to falling costs, faster underwriting, and improving policy terms, RWI has risen in popularity in recent years. However, it remains a specialized product—penetration of RWI in U.S. private-target deals remained less than 10% in 2015.
An RWI policy can be either “buy-side” or “sell-side”. When the Buyer is the insured (a buy-side policy), RWI can reduce or eliminate the need for an escrow because an insurer, rather than the sellers, indemnifies the Buyer for covered losses. When the sellers are the insured (a sell-side policy), they remain liable to the Buyer for breaches—typically through the two-tiered structure—but RWI compensates the sellers for covered losses. Buy-side policies are the dominant form of RWI today, comprising at least 80% of policies issued annually in the U.S. according to major insurers and market data.
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