Insurance in M&A Transactions

AbstractMergers and acquisitions (M&A) involve transactional risks, no matter how extensive and accurate the due diligence process is. This raises the question as to how transacting parties can be protected. Representations and warranties and indemnification provisions as well as escrow requirements, typically included in the acquisition agreement, may often prove to be inefficient and inadequate to this end. When negotiating these terms, transacting parties clearly have contrasting interests, and there could also be cases, especially in public company transactions or distressed sales, where the buyer may have no effective remedies against the seller after the closing.To overcome problems associated with seller’s indemnities, transacting parties increasingly avail themselves of some innovative insurance products, generally known under the catch-all name of “transactional insurance,” that provide coverage for risks arising out of extraordinary corporate transactions, including risks related to breaches of representations and warranties, tax liabilities, pending or potential litigation and other contingent liabilities.This chapter explores the role that insurance can play in managing transactional risk, discussing whether it may represent an efficient alternative to more traditional, contractual solutions like indemnity and escrow requirements. The discussion suggests that transactional insurance can serve as an effective risk-transfer tool in M&A, which may act as a supplement or also a substitute for seller indemnity obligations. By spreading transactional risk, insurance can facilitate M&A transactions and enhance the overall social benefit, providing economic security at a fraction of the cost that it would take for transacting parties to protect themselves. No problems of adverse selection or moral hazard peculiar to the M&A context seem to arise and a steadily increasing use of insurance in M&A can be expected.