Page 24 - Representation & Warranties Insurance

Recovery of Losses

An RWI policy specifies the types and amounts of One unique element regarding the evaluation of losses
losses the insured is entitled to recover if a breach under RWI claims involves the information that may be
occurs. Losses may be determined in a variety of ways available to the insurer regarding the original purchase
depending on the individual facts associated with price negotiations; for example, evaluating how the
the claim. Common types of claimed losses include original purchase price was arrived at by the buyer
the amount by which a buyer overvalued a company and seller (for example, a market approach versus an
due to its reliance on an incorrect representation or income approach) may be an important consideration in
warranty and direct out-of-pocket costs the buyer calculating losses. Because the insurer was not directly
incurs to remedy an issue (for instance, payments involved in the buyer’s and seller’s negotiations, it may
for an undisclosed liability). Regardless of type, such be unaware how those parties determined the final
recoverable losses are typically based on (a) the amount purchase price. If a large portion of those negotiations
the insured is entitled to receive in respect to a breach occurred verbally or without detailed documentation
pursuant to the terms of the underlying transaction (or if documents conflict), this may increase the
agreement, plus or minus (b) any adjustments based on difficulty an insurer has in assessing loss calculations.
terms unique to the insurance policy. In such instances, the insurer may need to assess the
reasonableness of the buyer’s assertions without access
Losses Calculated Based on the Underlying Transaction to information controlled by the seller that could support
Agreement or refute such assertions. If the insurer ultimately
With respect to determining losses under the terms concludes the buyer did not rely upon a certain valuation
of a transaction agreement, see Chapter 5 (titled technique used as the basis of its claim (for example,
“Representation and Warranty Disputes”) of the 2012 a multiple of EBITDA), the insurer and insured may be
original publication of the AICPA FVS Section’s Mergers unable to resolve the claim without the formal dispute
and Acquisition practice aid (copyright updated in 2020). resolution process specified in the RWI policy.
Common issues about determining losses under the
terms of a transaction agreement include whether Adjustments to Loss Calculations Based on Unique
losses should be calculated on a dollar-for-dollar basis Terms of the Insurance Policy
(commonly used for one-time events) or using a multiple An RWI policy may contain unique terms that adjust
(commonly used for permanent reductions of earnings losses that would otherwise be determined under the
that will continue to affect the business into the future). transaction agreement. For example, an insurance policy
Moreover, in assessing a loss, the insured should may contain exclusions that prohibit recovery in certain
evaluate whether the transaction agreement prohibits instances (for instance, prior knowledge of the breach).
recovery through a representation and warranty claim, As a result, the insured should evaluate its policy closely
because the loss has already been recovered through prior to calculating any losses to confirm that such
a different provision of the transaction agreement (for losses are not prohibited.
example, a working capital adjustment).

20 Representations and Warranties Insurance