- Protects against seller's breaches of representations and warranties and losses that may arise therefrom post-closing.
- Reduces or eliminates seller's indemnify obligations
- May provide additional protection over specified indemnities
2. Not intended to provide protection against:
- "Knowledge" of a breach (no sandbagging to be allowed from insurer's perspective) - insured prefers to limit knowledge to actual knowledge (no constructive knowledge) and limit "Knowledge Persons" to as small a group of management employees as possible.
- "Fraud" - definition of fraud as a carve-out from the coverage needs to be reviewed with caution; ensure that definition in the purchase agreement is identical to the definition in the insurance policy; the broader the definition of fraud, the greater the risk of buyer; seller (e.g., PF funds in platform sales) needs to ensure that (i) buyer does not amend or modify the policy in a manner that is adverse to seller (attache the policy as an exhibit) and (ii) buyer does not enter into any agreement with any person (insurer) that is broader than or inconsistent or conflicts with buyer's rights, interests or obligations under the purchase agreement (e.g., scope of subrogation rights in the policy) and any such broader, inconsistent or conflicting right, obligation, covenant or agreement will not be effective or binding against seller.
- Working Capital Adjustment - purchase price issue
- Adequacy of specific reserves on a balance sheet
- Underfunded pension obligations
- Covenants of a seller (state of matters v. actions)
- Absence of due diligence (moral hazard)
- Forward looking statements
3. Buyer's perspective
- Increase or augment indemnity
- Extension of survival period of reps and warranties (24 m - 36 m up to 6y; 6y for fundamentals)
- Ease of collection
- Backstop in public deals or seller bankruptcy
- Sweeten bid in auction
- Manage post-closing relationships with customers, suppliers and management of target
4. Seller's perspective
- Reduce contingent post-closing liabilities
- Enable distribution of all sale proceeds upon closing
- Protect passive sellers (LPs)
- Attract best bids by maximizing indemnity
- May offer separate indemnity package for tax, employment, environment or real property
5. Usage
- More frequently used in stock deals, PIPES, mergers and Section 338(h)(10) transactions where buyer assumes pre-closing liabilities
- Less frequently used in asset transactions where seller is retaining pre-closing liabilities
6. Terms
- Coverage: 100% plus of purchase price or may bifurcate (fundamental v. regular reps)
- Retention (Deductible): seller's skin in the game; 1-2% of purchase price; esp. insisted regarding fundamental reps and warranties; step-down retention after a certain period post-closing
- Premium: as of 2016 2-4% of coverage
- Underwriting fee: $15,000-$50,000
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