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 Seller’s representations and warranties. For M&A deals involving the acquisition of a private target entity, the Sellers typically bear the indemnification risk. This risk has traditionally been managed using a two-tiered structure: (i) a holdback or escrow funded from proceeds the sellers ultimately expect to receive, and (ii) in the event of a claim beyond the holdback or escrow, the right of the Buyer to clawback proceeds from the Sellers directly. In the late 1990s/early 2000s, RWI emerged as a niche tool to shift some or all indemnification risk to an insurer. Due to falling costs, quicker and more efficient underwriting, and improving policy terms, RWI is rising in popularity in recent years. However, in the U.S., it remains a specialized product that many M&A professionals are still learning about.
An RWI policy can be either “Buy-Side” or “Sell-Side”. When the Buyer is the insured (a Buy-Side RWI Policy), RWI can reduce or eliminate the need for a holdback or escrow because the Buyer can pursue the insurance policy instead of pursuing the Sellers, although it should be noted that the Sellers may remain liable for purchase price adjustments and other excluded matters, as well as for liability above the insurance limits and for fraud. When the sellers are the insured (a Sell-Side RWI Policy), they remain liable to the Buyer pursuant to the underlying acquisition agreement, but the insurance policy serves to protect the Sellers against covered losses when the Buyer seeks indemnification from them with respect to breaches of their representations and warranties.
In the U.S. market, Buy-Side RWI is more prevalent than Sell-Side RWI, comprising a large majority of the RWI policies issued according to major insurers and available market data.
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