The Benefits of Representations and Warranties Insurance

Private REIT transactions are becoming more and more popular, as Allen Matkins attorneys Ben Fackler and Max Brunner have explained, but the transactions operate much differently than a standard real estate transaction. As a bit of risk assurance, representations and warranties insurance has also become more popular for these deals. While this insurance provides protection, it isn’t a one-size-fits-all solution and needs to be negotiated into the deal.

“Representations and warranties insurance is increasingly popular in transactions of this type, because it allows a third party to stand in to provide assurance for some risks and removes a key part of the seller’s exposure in these transactions,” Brunner, senior counsel at Allen Matkins, tells GlobeSt.com. “The buyer will typically purchase this representations and warranties insurance policy instead of the seller because knowledge of an issue will be an exclusion from coverage, and the seller will always have more complete knowledge. This insurance does not have standard terms and will require significant negotiation with counsel with experience with these types of policies.”

The insurance does have benefits, but it comes with a price tag. “You should also note that this representations and warranties insurance carries a not insignificant premium, generally around 2-3% of coverage limits, typically requires a degree of self-insurance—called a strip—and is typically capped at 10% to 15% of deal value,” says Fackler, a partner at Allen Matkins.

In addition, this insurance doesn’t cover all potential problems and risks, and buyers should understand the limits. “There are categories of risk that are expressly excluded from these policies, including known issues, covenant breaches, purchase price adjustments, certain environmental exposures and employee misclassification,” says Fackler. “And the insurer may seek to add deal-specific exclusions around issues identified in diligence.”

As a result, the buyer may also need to negotiate an indemnity with the seller. “An indemnity from the seller may be necessary to protect against key exposures not covered by representation and warranties insurance, including fundamental issues that could result in a total loss of purchase price,” adds Fackler.