Representations and Warranties Insurance and Beyond

Written by Richard Romero

Knowing that an investment is in good hands should things go awry is something that all buyers in a healthcare transaction would like to take comfort in.  Luckily, there is transaction insurance in the forms of representations and warranties, and more.  The Ambulatory M&A Advisor explains how these insurances work and how they can ultimately enhance the value of a deal as a whole.

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.

Alice Gosfield, attorney and owner of Alice G. Gosfield and Associates says representations and warranties in general typically address the appropriate organizational structure of the selling entity, the compliance with applicable laws, the payment of applicable taxes, the appropriate authorization for professionals to render services (e.g., all are properly licensed), the maintenance of appropriate ancillary authorities (e.g., depending on the deal DEA numbers, medical staff privileges) that no one has been excluded from the public programs, sometimes that no one has been excluded from provider networks, that no one is currently under investigation by a government entity.

Gina Campanella, principal with Campanella Law Office LLC explains that representations are essentially a recitation by the parties of what they represent to be the pertinent facts relevant to the transaction.

“For example, the seller will represent that he or she is the owner and has the authority to sell.  Warranties often go hand in hand with these representations because, by making such a representation in a contract, they now become warranties.  In accordance with the example above, if a purchase were to close and a third party suddenly appears claiming they had an ownership interest in the property sold, should the third party have an actual claim the buyer will have remedies against the seller for making a false representation of ownership in the contract,” Campanella says.

“There are many common items that will be addressed in a representations and warranties section, such as ownership, lack of claims against the business, etc. but you can really ask for inclusion of a representation and warranty against anything that may concern you.  For example, if you are concerned that the books and records you are being presented with are not accurate, you may ask the seller to represent and warrant that they are in the contract.  This is why it is very important to conduct a thorough due diligence investigation during the due diligence period of any transaction. ”

Brian Berlandi, managing partner, Berlandi, Nussbaum & Reitzas LLP says some of the biggest reps and warranties that he see are ones that which the seller will rep and warrant that they are in a litigation investigation, audits relating to billing, reimbursement or malpractice.  Another big one is that all of the applicable licenses and approvals from various regulatory authorities are in place.

“A lot of those risk factors can be verified.  You can go to the regulatory agencies and verify whether or not the seller has all of their licenses.  You can run litigation searches and see if they are involved in any.  It is harder to know if they are the subject of investigations or audits because no one is going to tell you that,” Berlandi says.

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.”

There are also some things that relating to employment practices, which rep and warranty policies wont cover.  Oftentimes things like the classification of a particular employee for tax purposes and certain kinds of employee claims against an employer are not covered.

In addition, in the healthcare arena, Epstein says a lot of healthcare compliance is not covered, particularly around things like fraud and abuse.

Campanella adds that regardless of reps and warranties and other insurances, there is always risk in any purchase.

“Representations and warranties are generally not going to provide a buyer with remedies should anything happen that is considered within the anticipated risk of the transaction,” she says.

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.

Berlandi adds that things like tax indemnity insurance, and contingent liability insurance are two other types of insurances that he sees; contingent liabilities being things that may occur but have not yet.

“Those are the two normal ones that I think people see in modern healthcare deals.  The healthcare world is different than everything else, so it is hard to get these kind of coverage plans in healthcare deals,” Berlandi says.

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.

If you have an interest in learning more about the subject matter covered in this article, please contact Berlandi Nussbaum & Reitzas LLP: info@bnrllp.com or (212)804-6329.