Advantages and disadvantages of representations and warranties insurance

Numerous company sale operations (M&A) are carried out annually in Spain. It is essential to be aware of the advantages and disadvantages of representations and warranties insurance, a mechanism available to both buyer and seller to successfully carry out these types of operations and reduce their risks.

Advantages of representations and warranties insurance

Representations and warranties insurance offers advantages both for both parties and for each of the parties (seller and buyer).

Advantages of representations and warranties insurance for both parties

The main advantage of this type of insurance for both parties lies in the peace of mind provided by the presence of an independent third party. On the one hand, it will be this third party to whom the risks that may arise from a breach will be transferred to. On the other hand, in the event of non-compliance, this independent third party will be responsible for studying and determining whether the breach is justified or not, and whether compensation is therefore possible. The intervention of an insurance company may therefore favour the negotiations of an M&A operation and make both parties feel more comfortable and protected.

Advantages of representations and warranties insurance for the seller

  • The company for sale and therefore the seller himself, are more attractive when they is insurance, since the buyer is more secure regarding the claims that may arise from a breach of the statements included in the contract of sale
  • There is a limitation of the seller’s liability once the operation is closed, as any subsequent claim will be made directly to the insurer
  • The seller has the possibility of receiving the full amount of the sale price of the transaction without deferred payments, deposits or other alternatives.

Advantages of representations and warranties insurance for the buyer

  • Peace of mind for the buyer, since on the one hand he will receive broader representations and guarantees from the seller, and on the other, he will be certain that in the event of non-compliance the corresponding compensation will be paid, provided that the insurer has a high credit rating
  • If the operation is totally or partially financed by a bank or credit institution, contracting this type of insurance will generate more peace of mind for that institution
  • The contracting of a policy by the buyer can make his offer more attractive and competitive than others.

Disadvantages of representations and warranties insurance

While there are numerous advantages to contract a representations and warranties insurance, it is also necessary to point out the disadvantages that may occur when signing this type of insurance. The most important are:

  • The additional expense involved and which will increase the cost of the operation
  • The loss of confidentiality due to the inclusion of an external third party to the transaction (the insurer and its advisors) and the delivery of due diligence documentation add complexity to the transaction
  • The rejection that may generate in the buyer who may prefer to opt for simpler and less expensive alternatives, such as bank deposit (escrow).

There are advantages and disadvantages for the contracting of a representation and warranty insurance, the essential thing is that the buyer and seller agree on the best option for the transaction that they are going to carry out.

This article is not considered as legal advice

Belén Crego

Belén Crego has a double degree in Spanish-French Law and specializes in business law, company law and procedural law. Working languages: English, French and Spanish. Contact Belén Crego