Member Article

Peter de Boisblanc, HUB International, also contributed to this article.

The COVID-19 pandemic has impacted the economy to a significant extent. With respect to the representations and warranties insurance (“RWI”) market, the pandemic presents two specific challenges: (1) a reduction in M&A activity, and the resultant decline in RWI premium spend, has caused insurers to fall behind on their annual revenue targets; and (2) many transactions submitted for insurance during this period have relatively unfavorable risk profiles. Fortunately, M&A activity seems to be picking back up, with an emphasis on transactions involving distressed entities and tech and health IT companies. This update discusses how the RWI market is responding to the COVID-19 pandemic and this new normal, but with a view to providing you with guidance as to what you should expect when placing an RWI policy.

Background: The increased risk profiles of deals in the current environment.

From a buyer’s perspective, the primary purpose of the M&A due diligence process and representation and warranty package is to understand and eliminate risks existing in the target company. The COVID-19 pandemic has increased the challenge of identifying and quantifying these risks because of the myriad and far reaching potential effects of COVID-19 on any given target company. Indeed, nearly any representation or warranty in an acquisition agreement theoretically later could be argued to have been inaccurate due to COVID-19. Just to take a few examples: (i) a financial statements representation (which typically includes a statement that the financials “fairly represent” the financial condition of the business) arguably could be inaccurate if the impact of the COVID19 economic downturn is not reflected in those statements; (ii) a compliance with laws representation arguably could be inaccurate if the target had been operating in “survival mode” in response to the COVID-19 pandemic and failed to dedicate sufficient resources to its compliance function (including monitoring and complying with the bevy of new laws or regulations enacted in response to COVID-19); or (iii) a customer or supplier representation arguably could be breached if the disclosure schedules did not reflect that certain customers or suppliers had ceased operations due to COVID-19 or expressed an intention to reduce their relationships with the target. Even if such representations are qualified by “seller’s knowledge”, such knowledge qualifiers often carry a “due inquiry” standard or similar concept of constructive knowledge that imposes a burden on the target to affirmatively verify the accuracy of its representations.

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