Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / How the Reps and Warranties Insurance Trap Buried a $200 Million Deal
Transcript
- Lucas: When you hear reps and warranties insurance described as a 'no-brainer' for sellers, run the other way. Because I just finished looking at a case where the RWI policy was the reason a two-hundred-million-dollar deal turned into a lawsuit. Luna: Wait — the insurance is supposed to protect the seller from post-close claims, right? That's the whole pitch. Lucas: That is the pitch. And in this deal — let's call it a B2B SaaS company, forty million in recurring revenue, clean financials — the buyer insisted on RWI as a condition of closing. Seller thought: 'Great, I won't have to hold back a huge escrow.' Problem was, nobody read the subrogation clause. Luna: Subrogation — that's the insurer's right to step into the buyer's shoes and sue the seller after paying a claim, right? Lucas: Exactly. Standard RWI policies include it. The insurer pays the buyer for a breach, then turns around and sues the seller to recover what they paid. So the seller ends up in exactly the same position as if they'd had no insurance — they're writing a check, just to a different entity. Luna: So the 'protection' is really just a pass-through mechanism. The insurer is a middleman that collects premiums and then litigates. Lucas: Right. In this case, the buyer filed a claim six months post-close, alleging the seller had misrepresented a customer concentration figure. The policy paid out eight million dollars. Then the insurer subrogated and sued the seller for the full eight million, plus legal fees. The seller eventually settled for four million, because the cost of fighting was higher. Luna: And the seller's attorney hadn't negotiated a waiver of subrogation? Lucas: They didn't even ask. The binder — that's the insurance summary — had a clause saying subrogation was 'standard.' The seller's team assumed it meant the insurer would go after third parties, not the seller. Classic misread. Luna: Okay, but if a seller negotiates a non-subrogation clause, doesn't the premium skyrocket? I've heard underwriters treat that as a huge risk. Lucas: It does increase the premium, typically by fifteen to thirty percent. But in a two-hundred-million-dollar deal, that's a rounding error compared to a four-million-dollar settlement. And there's a middle ground: a carve-out for fraud or intentional misrepresentation. Underwriters will usually agree to waive subrogation for everything except fraud. That's the sweet spot. Luna: So the seller in this case could have paid maybe an extra fifty thousand dollars in premium to avoid the four-million-dollar hit. That's an eighty-to-one return. Lucas: Exactly. But they didn't know to ask. And the buyer's advisors certainly weren't going to point it out. The other structural issue was the policy's 'tipping' mechanism — the threshold for when the insurer can subrogate. Luna: Tipping being the dollar amount above which subrogation kicks in? Lucas: Right. In this deal, the tipping basket was set at one percent of the purchase price — two million dollars. So any claim above two million triggered full subrogation rights. The seller could have negotiated a higher tipping point, say five percent — ten million dollars — which would have absorbed small claims and only exposed the seller to subrogation for truly material breaches. Luna: Which sounds reasonable, because if a breach is that big, the buyer probably has a real argument. But for anything under ten million, the seller walks away clean. Lucas: Right. And here's where it gets worse: the policy also had a 'coordination of benefits' clause that required the seller to reimburse the insurer if the seller recovered anything from a third party related to the claim. So the seller couldn't even go after a former employee who caused the issue — any recovery went straight to the insurer. Luna: That basically eliminates the seller's ability to mitigate their own loss. It's a one-way street. Lucas: It is. And it's standard in many policies unless specifically negotiated out. The seller in this case didn't have the leverage to push back because the buyer had three other bidders waiting. But even in a competitive process, sellers can insist on a 'no subrogation except fraud' clause and frame it as a deal-protection measure — because it reduces litigation risk for both sides. Luna: Let me guess — the buyer in this deal had the RWI policy structured so that the premium was paid by the seller as a credit against the purchase price? Lucas: How did you know? Yes, the seller 'paid' the premium via a purchase price adjustment. So they funded the very weapon used against them. The total cost to the seller was about three hundred thousand dollars in premium, plus four million in settlement, plus legal fees. And they still had to cover their own defense costs because the policy didn't cover defense in subrogation actions. Luna: This is the kind of detail that makes me think every seller should hire a dedicated insurance broker who only does transaction liability. A general corporate attorney might not see this coming. Lucas: Absolutely. And there's a growing niche of brokers who specialize in RWI placement. They know the underwriters, they know which carriers will accept non-subrogation language. The seller in this case used the buyer's recommended broker — huge mistake. Luna: So what's the one takeaway? If a seller hears 'RWI' in a term sheet, what should they do first? Lucas: Demand a copy of the binder or the policy draft before you sign anything. Look for the subrogation clause. If it says 'standard' or 'as per insurer's usual terms,' that's a red flag. Then ask your attorney to propose a waiver of subrogation for all claims except fraud. And negotiate the tipping basket — make it high enough that small claims don't trigger subrogation. Luna: That's concrete. I can imagine a seller reading this and thinking, 'But won't the buyer walk if I ask for too much?' Lucas: They might. But in a competitive process, the buyer is already emotionally invested. And if you frame it as a risk-reduction move that also saves the buyer litigation distraction, it's a fair ask. The worst they can say is no, and then you know the buyer's intentions. Luna: It's like the insurance is only valuable if you can trust the counterparty not to use it as a weapon. And trust in M&A is, well, rare. Lucas: Rare indeed. Look, if today's episode saved you even one sleepless night on your next deal, that's the kind of thing that makes this whole podcast worth doing. If it was worth a coffee to you, you know where to find us — buy me a coffee dot com slash fexingo. Seriously, even a small contribution keeps the ad-free lights on. Luna: Yeah, it's a small way to say this conversation moved your work forward. We appreciate it. Lucas: Alright, back to the deal. The other lesson from this case is about the timing of the RWI placement. The seller's team waited until after the letter of intent was signed to start the insurance process. That gave them virtually no leverage. Luna: Because the buyer already had exclusivity, so the seller couldn't shop for better terms. Lucas: Exactly. If you're a seller, get indicative RWI terms before you sign the no-shop. Approach three or four carriers, get quotes that include non-subrogation language, and have those terms ready to insert into the definitive agreement. It changes the negotiation dynamic entirely. Luna: So pre loi insurance shopping. That's a tactical move most sellers don't think about. Lucas: Most don't. But the ones who do close with better terms. There's a study by a placement firm — I think it was Aon — that found sellers who locked in RWI terms before signing the LOI reduced their post-close exposure by an average of forty percent. That's real money. Luna: And in this deal, if the seller had done that, they'd be four million dollars richer. That's a pretty expensive lesson. Lucas: It is. And the sad part is, the underlying business was solid. The customer concentration issue was real but minor — the buyer could have lived with it. The RWI claim was basically a negotiating tactic to claw back some purchase price. And the subrogation clause gave the insurer the incentive to pursue it. Luna: The insurer gets paid to investigate and litigate. They're not your friend. They're a for-profit entity that makes money by denying claims and subrogating. Lucas: Right. And that's the fundamental misunderstanding. Sellers think of RWI as a shield. But without structural protections, it's a sword in the buyer's hands. The key is to reforge it into a real shield — one that protects both sides from unnecessary litigation. Luna: So for anyone listening who's considering an exit, the homework is: get a transaction liability specialist, negotiate subrogation before the LOI, and set the tipping basket high enough to matter. Lucas: That's the playbook. And if you want a checklist to take to your attorney, we'll post one in the show notes — no subrogation except fraud, tipping basket at five percent of purchase price, and seller controls defense of any subrogation claim. Those three terms would have saved this deal. Luna: I think that's a great note to end on. Thanks, Lucas. Lucas: Thanks, Luna. Talk to you next time.