Representations usually refer to the past and present, and
warranties to the future.
R&Ws relate to aspects of a seller’s business and/or
standing and are included in contracts to provide counterparties
with certainty and comfort around the target in an acquisition
context.
A simplified example of an R&W is where a seller provides
that there will be no material impact to the revenues generated by
the target during the period of time leading up to the sale and in
the first year of operations following the sale.
R&Ws are heavily negotiated as part of a typical acquisition
and are tailored to be deal-specific in many instances.
R&W insurance is transactional protection typically
purchased by the buyer in a given transaction, giving rise to a
claim where the seller breaches a covered representation and/or
warranty.
The coverage is attractive to both parties as the seller can
exit the deal without, or with fewer, strings attached.
For example, in transactions without R&W coverage some deals
are structured such that a percentage of the purchase price is
withheld for a set period of time, for example one year, and until
certain R&W periods have come to an end.
This is less attractive to a seller who does not get a clean
break and may also have to provide a seller indemnity.
Alternatively, where R&W coverage is in place, the seller
walks away with full payment at the time of closing and the buyer
has recourse to the R&W insurer for compensation where the
target breaches a R&W, which limits its exposure to any
breach.
R&W coverage can be obtained on the open market, typically
using a broker to source quotes and relay relevant information to
and from the insured – and in relation to the target –
before pricing can be considered.
As the buyer, and/or buyer’s counsel, is carrying out due
diligence on the target, the prospective insurer, via the broker,
will be doing a similar exercise – evaluating the risks
associated with the transaction, seeking to mitigate those risks
using R&Ws, and ultimately agreeing to insure against breach of
those R&Ws.
For companies or groups who are particularly acquisitive, the
process of going to market to obtain coverage in each instance may
become overly time consuming and/or costly.
In some instances, using a captive insurer to cover some or all
of the R&W risks makes a compelling economic case.
This is especially true where claims are historically low, and
processes for assessing targets are well-honed.
Bermuda captives are well-suited to such risks. The island’s
insurance regulator, the Bermuda Monetary Authority, has tended to
a highly-regarded and world leading captive market for many
decades.
As such, the BMA is well-placed to expediently consider and
approve of R&W business, written through an existing Bermuda
captive or through a new Bermuda captive.
In the former example, an existing captive can expand the
footprint of its business plan to include R&W risks by
submitting an application to the BMA’s Assessment and Licensing
Committee for approval.
In the latter scenario, where a company or group is seeking to
form a new captive, incorporation of a new Bermuda company can run
concurrently with the preparation of BMA application materials for
efficiency.
As with the existing captives, application for a new captive
license goes to the BMA’s ALC and a response is usually
received in the same week as the submission of the application.
Utilising a Bermuda captive for R&W risks has a number of
advantages.
For example, transactional efficiency – a reduction in the
time to closing given the target familiarity.
Other advantages include a reduction of intermediary fees, lower
volatility in pricing, ready-to-deploy capacity, generation of
premium as a source of revenue over time, and diversity in risk
management tools.
Of course, there are costs associated with the set-up and
ongoing operation of a captive, however in several recent examples,
the benefits significantly outweighed these costs.
Additionally, Bermuda captives can be used to cover other lines
of business such as worker compensation, employee benefits, or
other risks that a company or group may face.
In addition to those regulatory benefits, Bermuda offers a
number of other attractive features.
Bermuda is proximate to major insurance markets in the gateway
cities of New York and London, and it is, in itself, a leading
reinsurance domicile affording proximate access to a
well-established reinsurance market.
The island also has a wide array of experienced and
well-equipped service providers who can help to bring a captive
online in a cost-efficient and expedient manner.
We hear of cyber and ESG-related risks as being emerging in the
captive context, but the island may well see R&Ws coverage as
another growing risk category for Bermuda captives going
forward.
First Published in The Royal Gazette, Legally Speaking
column, September 2023
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
