James D. Epstein Quoted in the Ambulatory M&A Advisor Article, 'Representations and Warranties Insurance and Beyond'
James D. Epstein, a partner in the Commercial Department of Pepper Hamilton, was quoted in the November 18, 2016 Ambulatory M&A Advisor article, "Representations and Warranties Insurance and Beyond."
James Epstein, partner at Pepper Hamilton LLP says that essentially, the product that is being used for representations and warranties insurance is being used to back stop an indemnity obligation of a seller, or as a substitute for an indemnity obligation of a seller.
"The risk that you are trying to deal with is that the statements that are in those reps and warranties turn out to be false in some way and there is some liability or other issue for which the buyer believes it should be compensated. That insurance policy provides a fund for the compensation for those liabilities or other obligations," Epstein says.
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Epstein says that not all things in a transaction are covered in reps and warranties.
"There are typically some exclusions and they should be thought about as things that require judgment calls. For example, in rep and warranty policies, they will typically cover whether you have paid your taxes. However, what it might not cover is the value of a net operating loss," Epstein says.
"So, if there is a representation that the buyer is receiving a million dollars of net operating losses from the seller as part of the transaction, typically, because that requires estimations and a lot of value judgments, the policy will not cover something like that."
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In addition, in the health care arena, Epstein says a lot of health care compliance is not covered, particularly around things like fraud and abuse.
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Epstein explains that aside from reps and warranties, there are other insurances, and the use of them really depends on the company.
"For example, if you have a company that is really environmentally sensitive, you can buy environmental insurance that will cover past issues at a particular site or a series of sites that you may be acquiring. There is also typically insurances available to cover certain tax liabilities. Some of those actually can be cheaper in terms of cost, but it also depends on the risk profile and the specific issue you are trying to cover," Epstein says.
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On the possibilities of insurance in a transaction impacting value, Epstein says that currently, sellers are using it as a tool to do a couple of things.
"One is to first and foremost limit their own liability, but also to provide for a mechanism by which buyers can get a greater amount covered for claims. In middle market transactions, it is not uncommon for people to limit and cap the exposure, and those caps have been coming down with a lot of it depending on how good the asset is that is being marketed for sale," he says.
"If you have a hot company being sold, the likelihood is that you are going to have a much lower cap, because you are going to have people competing at the auction to try and buy this company. If you assume that you are going to end up with a five percent cap, what the insurance generally does is enable you to increase that cap over and above that five percent."
Epstein says in some ways there is a benefit in insurance that is afforded to the buyers in the form of a higher cap, and there is a benefit that is in favor to the sellers because they don't have to take that five percent of the purchase price in escrow.
Content contributed by attorneys of Troutman Sanders LLP and Pepper Hamilton LLP prior to July 1, 2020, is included here, together with content contributed by attorneys of Troutman Pepper (the combined entity) after the merger date.