When negotiating the sale of a bank, the buyers and sellers often engage in a kabuki dance over the indemnification provisions of the agreement. What should you expect as a buyer or a seller when it comes to these terms?
Every two years the American Bar Association publishes a Private Target Deal Points Study, which is widely recognized as the gold standard for market metrics of key negotiated legal issues in M&A agreements. While acknowledging that this study focuses on deals larger than your typical Iowa transaction, the study results can prove to be very useful in negotiations. This article will highlight some key findings that may be of interest to bankers.
Survival Period of Representations & Warranties
Frequently debated is the survival period of the representations and warranties. In over 80 percent of deals in the study, the survival period was between 12 and 18 months with 27 percent being exactly 12 months, 18 percent being between 12 months and 18 months, and 38 percent being exactly 18 months. The remaining deals had survival periods greater than 18 months or no express survival period.
Just over three quarters of deals included some sort of escrow or holdback. In bank transactions this is usually tied to suspect loans and other items that cannot be quantified at the closing. The study results showed that the escrow size was:
Caps on Indemnification
Nearly 80 percent of deals had a determinable cap on indemnification, and in 59 percent of those deals the cap was less than 10 percent of the deal value. Fifteen percent of deals had a cap of exactly 10 percent, and an additional 15 percent had a cap between 10 percent and 15 percent. Only 7 percent of deals had caps between 15 percent and 50 percent, and 4 percent of deals had caps equal to the entire purchase price.
On the other hand, 65 percent of deals had no eligible claim threshold. Ninety-five percent of those deals with a basket had a basket size of 1 percent of the deal value or less (45 percent with 0.5 percent or less, and 50 percent with between 0.5 percent to 1 percent). Only 2 percent of deals had a basket size greater than 2 percent of the deal value. Seventy percent of the baskets were a deductible from any indemnification claims. Just 26 percent were first-dollar baskets.
Representations & Warranties Insurance
Representations and warranties insurance is a relatively new concept. It is intended to take the place of indemnification by the seller. In the deals analyzed, 29 percent included representations and warranties insurance (RWI) in the definitive agreement. In 23 percent of deals, RWI was the buyer’s sole source of recovery for all representations, and in an additional 18 percent of deals, RWI was the buyer’s sole source of recovery only for non-fundamental representations. Additionally, 45 percent of deals required the buyer to pursue indemnification claims under the RWI policy.