Legal Affairs News Channel
There has been much discussion about the role of representations and warranties (“D&G”), their function in contracts for the sale of shares/assets, and the liability that arises from their inaccuracy or falsehood. Fundamentally, D&Gs are tools in M&A transactions used to manage and allocate risks. This is how the party who makes a statement assumes the risk that the facts or state declared regarding a company or the party itself are not true.
As a general rule, falsehood or inaccuracy may result in breach of contract and loss for the buyer. The commonly adopted mechanism to ensure that the buyer is compensated for losses caused involves the retention of a part of the price, either by the buyer (holdback) or by a third party (escrow). The first involves retaining a portion of the price by the buyer for a certain time. The second, the constitution of an escrow account where the buyer deposits a part of the price, which is retained by an agent for a period of time, the disbursement of which involves the occurrence of certain events and the sending of an instruction.
However, the use of warranty and indemnity insurance (W&II) has increased as a coverage mechanism for the parties. This mechanism is mainly offered under three product types:
1. Guarantee and indemnity insurance: seeks to protect the parties from a loss arising from non-compliance or misrepresentation in the D&G. In this way, the risk is transferred from the non-compliant party to a specialized third party, or insurer;
2. Insurance that covers tax/fiscal risk: seeks to reduce or eliminate the exposure of a tax risk as a result of a challenge or audit by tax authorities, regarding the tax treatment applied to a transaction. This insurance seeks to transfer the fiscal risk from the taxpayer to the insurer; and
3. Litigation and contingent risk insurance: seeks to cover and compensate: (i) losses caused by damages faced by the defense of a company due to an active lawsuit or possible litigation (adverse judgment insurance), or ( ii) a favorable result in the first instance when an appeal is adverse for the initially winning party in a process (judgment preservation).
This is how insurance companies (or underwriters) have sought to delve deeper into the M&A market by offering a service that adjusts to the needs and preferences of the parties. Although in Colombia this mechanism has been adopted in only 8% of transactions, in Europe the trend has increased to 16%, a figure analyzed thanks to the annual studies prepared by the CMS global network (CMS European M&A Study 2024). .
On the one hand, the proactivity of insurance companies to make themselves known and familiarize the parties in these transactions with the advantages they can offer to distribute risks will be decisive. On the other hand, this alternative is presented as an opportunity for the parties and their advisors to: encourage the disclosure of transparent and sufficient information; structure more attractive contracts in competitive transactions; close transactions that in principle may be hindered by deal breakers and protect commercial and even personal relationships, post-closing.
