Question

Summarize how to negotiate the acquisition of Intellectual Property and Financial Liabilities, Human Capital, Price and Consideration Issues, and Escrow Issues. Are you satisfied that KP&T’s operation of its business does not infringe, misappropriate, or violate any other parties’ patents or other IP rights? Can you verify that no other party is infringing, misappropriating, or violating KP&T’s IP rights? Can you confirm there is no litigation and there are no claims covering any of the above that is pending or threatened, or that could be reasonably expected to be brought following the closing? Can this portion of the negotiation be settled? For financial liabilities, KP&T wants to exclude any items that result in obligations or liabilities below a specified dollar threshold set forth in the agreement. Will you agree to this? Explain. What are the terms of any new employment agreements with key management of KP&T? If there will be termination of employment of some of KP&T’s employees at or shortly following the closing, KPT&T is demanding that your company bears the severance costs. Will you agree to that? You argue that your company should get the business with a “normalized working capital”. KP&T is arguing that if there is a working capital adjustment clause, the target working capital should be low or zero. How do you resolve this disagreement? Will you negotiate an escrow or holdback of a portion of the purchase price to protect your company from losses due to potential breaches of the seller’s representations? Explain.

Answer 1

Representations and warranties insurance is an insurance policy used in mergers and acquisitions to protect against losses arising

due to the seller’s breach of certain of its representations in the acquisition agreement.

The Typical Process for Obtaining Representations and Warranties Insurance

The process for obtaining a policy usually starts with the buyer or seller approaching an insurance broker to solicit quotes from insurers. An application for insurance must be completed.

The following are the key information and documents the insurer will want to review:

The parties involved

The coverage amount sought

The form of acquisition agreement, especially the nature and scope of the seller’s representations and warranties

The seller’s online data room

The buyer’s due diligence reports on the seller

The seller’s Disclosure Schedule connected with the acquisition agreement

The process is usually in two parts: (i) an initial non-binding indication of interest which costs nothing and then (ii) an underwriting/due diligence process that requires payment of an upfront underwriting or due diligence fee (typically $15,000 to $50,000).

After the insurer’s due diligence, the insured will then negotiate the specific terms of the policy, such as the scope of losses included within coverage and excluded from coverage.

As with any other type of insurance policy, a carrier may deny a claim presented by the insured. The beneficiary of the policy may then need to resort to litigation or arbitration to recover its losses. This requires a specific type of legal expert who has had experience in dealing with insurers on such claims.

The typical reasons for denial by an insurer on a claim under a representations and warranties insurance can include:

The insured’s application for coverage was false or incomplete

The claim does not fall within a definition within the policy of a covered “loss”

The problem was known by the insured prior to the closing of the M&A transaction

The claim involves a covenant of the buyer, and not a representation or warranty

The deductible must first be applied before any recovery is available

The language of the particular representation or warranty has not been breached

The claim is within the type carved out by the policy (such as asbestos or wage and hour claims)