First offered in 1999, R&WI Policies are generally intended to provide coverage for breaches of representations and warranties made by the seller (or acquired entity) in a purchase agreement. These policies serve as either a supplement to, or in some instances a substitute for, the sellers’ obligations to maintain a portion of the transaction price in escrow to ensure that funds are available to indemnify the buyers in the event of a breach. Although coverage is available for both buyers and sellers, the vast majority of R&WI Policies underwritten are buyer-side policies in which the acquiring company or its affiliate is the named insured.
There are now at least 17 insurance carriers that offer R&WI Policies, and as the number of policies placed each year continues to grow, new carriers continue to enter the marketplace. The volume of claims submitted has, not surprisingly, expanded along with the number of R&WI Policies placed. The adjustment of claims under R&WI Policies raises complex issues, and a specialized claims practice is quickly developing.
Types of Claims
Claims under buyer-side R&WI Policies are generally first-party claims made by the insured buyer against the insurance carrier that placed the policy. Although specific policy terms may vary, the claims process typically includes the insured buyer’s submission of a notice of claim, followed by a more detailed proof of loss specifying the nature of the breach, the specific facts and circumstances establishing the breach, and a calculation of the damages resulting from the breach. The insurance carrier will then provide the insured buyer a written evaluation of the proof of loss, to which the buyer may provide a rebuttal. At that point, the parties will typically negotiate over the claim in an effort to resolve it.
If those negotiations fail, the insured buyer may elect to proceed with the claim under the dispute resolution process set forth in the policy, which is most frequently submission of the claim to binding, confidential arbitration. Many R&WI Policies provide for a “closed” arbitration, which, generally speaking and subject to certain exceptions, is limited to the parties’ submissions and other materials exchanged during the claims process, such as the notice of claim, proof of loss, evaluation, any mediation materials, and so on. This may reduce the overall cost of the arbitration, and it helps to promote the full development of the parties’ positions and evidence as part of the claims process. Because most claims are arbitrated and the arbitrations are confidential, there is little to no public legal precedent concerning R&WI Policy terms, and such precedent may be slow to develop. Experienced claims counsel with an understanding of how policy terms are interpreted in practice is therefore critically important.
Challenges for All Parties
The claims process poses challenges for both insurance carriers and insureds. The underlying legal claims often relate to alleged breaches by the sellers, but the sellers are not generally parties to the R&WI Policies or active participants in the claims process. Carriers are therefore tasked with adjusting a claim that a representation or warranty has been breached without the benefit of arguments, much less supporting evidence, from the party accused of the breach. The adjustment of claims thus requires significant diligence by carriers. Carriers have an obligation to adjust claims in good faith, and they take that obligation seriously.
For insureds, a thorough and well-supported proof of loss in support of a claim is therefore necessary, but not sufficient, to establish entitlement to payment. Even after providing such materials, insureds must be prepared for and cooperate with requests from insurance carriers for additional documents and information as the carriers evaluate the claim. Often, the nature of the alleged breaches will require both the insureds and the carriers to obtain assistance from experts. All of these steps take time, and insureds should not expect an immediate decision on or resolution of their claim. Even so, the claims process may generally be faster and less expensive for insureds than litigating post-closing indemnification disputes against sellers to recoup escrow funds.
To the extent that R&WI Policies supplement, rather than wholly replace, escrow and seller-indemnification obligations, insured buyers should also expect that insurance carriers will pay close attention to how the buyers resolve their separate indemnity claims against the sellers. Under a typical (though by no means universal) policy structure, the seller is effectively responsible for a portion of the policy retention through the indemnification escrow, with the insured buyer responsible for the remainder of the retention. This structure is popular for the insured buyer because it reduces the buyer’s exposure for the retention, and is of benefit to the carrier because it provides an incentive to the buyer to thoroughly vet the entity it is acquiring before closing. This also serves as an incentive to the seller to pay close attention to the representations and warranties it is making in the deal.
On the other hand, when a policy is structured in this way, carriers may view skeptically claims by insured buyers who seek to settle their indemnity claims with sellers for substantially less than the full escrow amount and then seek to recover the full quantum of damages from the carriers. Insured buyers should therefore consider their indemnity claims and their insurance claims as part of a single coherent strategy and avoid undermining their insurance claims through the manner in which they settle their indemnity claims with sellers (which the carriers must typically approve in advance under the R&WI Policies). Most R&WI Policies also provide for subrogation rights by carriers against the sellers in circumstances of fraud, which will further necessitate the coordination of such indemnity and insurance claims.
Companies seeking R&WI Policy coverage should shop with the claims process in mind. Choosing a policy based on cost alone may be a false economy if the insurance carrier is inexperienced or lacks a track record of paying meritorious claims. While claim settlements and arbitrations are often confidential, an insurance broker with experience in the marketplace can advise on carriers with whom past clients have had positive claim experiences, and purchasers should carefully consider such advice. The policy forms themselves are also highly negotiable and customizable, and small changes in phrasing can have immense consequences in the claims process. Companies purchasing such policies should always consult with experienced counsel.