The Real Estate Leasing Lawyer’s Role In an M&A Deal With a Reps & Warranties PolicyOctober 4, 2022 – Commercial Leasing Law & Strategy
It has long been the case that whenever the targeted assets in a merger and acquisition transaction include lease rights as to real property, a leasing lawyer has an opportunity to provide valuable services to the client in that M&A transaction. Leasing lawyers educate buying clients about the current status of the target’s leased real property assets, operations, rights, obligations, and liabilities and assist with plotting post-closing options. When representing sellers, leasing lawyers help their clients respond to diligence requests, evaluate and negotiate the sellers’ representations proposed by the buyer, and craft disclosure schedule content. For many years, these roles have remained largely unchanged. Over the past decade, however, the rising popularity of representations and warranties insurance policies invites even the most sure-footed real estate leasing lawyer to consider whether (and if so, how) his or her role changes if the subject M&A transaction includes an RWI policy.
This Article provides an overview of the most commonly-accepted purposes of an RWI policy and an overview of the RWI policy underwriting process. Then, a discussion follows regarding matters of which real estate leasing lawyers should be particularly mindful when performing their role in such a transaction.
Overview of RWI Policies
Generally speaking, an RWI policy provides a pool of funds from which the insured can obtain recovery if a representation and warranty of the seller in an M&A transaction’s purchase agreement is inaccurate and if that inaccuracy damages the buyer. In many cases, M&A deal parties have embraced an RWI policy to take the place of a hold-back of a portion of the purchase price intended to provide the buyer comfort that accessible funds existed from which the buyer’s post-closing indemnity claims (if any) against the seller could be satisfied.
RWI policies permit either the buyer or the seller to be the insured, but presently it is most common for the insured to be the buyer. [For this reason, this Article will focus on a buy-side policy.] An RWI policy contains a set of conditions and other terms that affect whether, under what circumstances, and to what extent the insured may recover. And, the R&W underwriting process runs—generally speaking—in parallel with the M&A transaction’s diligence process.
Because an RWI policy hinges most significantly on whether a representation and warranty in the subject purchase agreement is inaccurate, RWI underwriters and their counsel focus significantly on the language of those representations and warranties and on the disclosure schedules that accompany them. RWI underwriters and their counsel also seek to discern whether it appears that the buyer and its advisors (including its real estate leasing lawyers) conducted a fulsome and—in light of the nature of the M&A deal’s target—otherwise appropriate diligence exercise and whether it appears that the seller was appropriately responsive to the buyer’s diligence inquiries.
As to an RWI policy with respect to which the buyer will be the insured, RWI underwriters desire to obtain and review copies of written diligence reports from the buyer and its professional advisors. With respect to real estate leasing, it is common for such reports to include lease summaries and reference to any red flags that arose in the course of those reviews (such as whether any lease documentation is missing, any lease terms expire soon, or any consent-gathering process appears cumbersome or might trigger recapture rights on the landlord’s part). On buy-side deals, the buyer also grants to the underwriter and its advisors access to the M&A deal’s data room, so that the underwriter and such advisors can browse through (or more closely review) the materials contained within. RWI underwriters also typically lead an often-lengthy conference call with the proposed insured, its advisors, and the underwriter’s counsel during which they narratively discuss the diligence performed by the proposed insured, the results thereof, and the progress of the deal and identify any material outstanding matters.
Overview of the Underwriting Process
Generally speaking, underwriting for a buy-side RWI policy proceeds in this way: (A) the buyer engages an RWI policy broker who invites underwriters to bid on the opportunity to underwrite the RWI policy, (B) underwriters conduct an initial review of the then-available draft deal documents, financial statements, and an overview of the target’s business and respond to that opportunity to bid, (C) the buyer designates one of those underwriters as the underwriter for the RWI policy and pays it a non-refundable underwriting fee, (D) the underwriter begins its review of the purchase agreement, the disclosure schedules, the data room, and the diligence materials, (E) the underwriter leads the buyer and its advisors through that lengthy underwriting conference call, (F) the underwriter delivers to the buyer and its advisors (through the RWI policy broker) a list of follow-up questions and in many cases a list of proposed exclusions to the policy, and (G) thereafter all parties involved work to close-off those follow-up questions (including via the underwriter’s and its counsel’s review of successive drafts to the purchase agreement and the schedules and/or of updates to diligence reports) and to negotiate the proposed exclusions and, in some cases, other language in the RWI policy.
Tips for Handling Leasing Matters with an RWI Policy
Real estate leasing lawyers performing their work on an M&A transaction that features an RWI policy should bear in mind the following:
- “The deal” is now two deals: (a) the M&A deal and (b) the RWI policy negotiation. This reality might result in the leasing lawyer conferring with his or her M&A deal leader more frequently than otherwise and needing to shift gears between monitoring the M&A deal (on the one hand) and monitoring the negotiation of the RWI policy’s real estate-related terms (on the other hand).
- When serving as buy-side leasing lawyer, be mindful that the RWI underwriter will be acutely focused upon the representations and warranties that are proposed to be made by the seller and that, on the underwriting conference call, you might be invited to describe what diligence you performed as to each specific representation and warranty to confirm that they were accurate. This reality might cause you to attempt to trim back some of the proposed representations and, as to remaining representations, ensure that you actually diligenced each statement that is capable of being diligence. If the representations and warranties proposed in the purchase agreement are broader than the diligence you conducted, the underwriter might, following the underwriting call, seek to address that gap with one or more follow-up questions. Or, the underwriter might propose that, for purposes of the RWI policy, those un-diligenced representations will be deemed deleted. Worse yet, the underwriter might propose an RWI policy exclusion on the related liability.
- When serving as buy-side leasing lawyer, as you perform your diligence be mindful that the RWI underwriter is more likely to view the resulting written materials (such as your Q&A tracker and your law firm’s written diligence memo) as helpful and as professionally composed if you do not appear to have failed to follow up on diligence questions that the seller did not fully answer. You will aid your client by fully answering as many questions as possible prior to the underwriting conference call, so that such call does not become unwieldy or otherwise invite further scrutiny into your client’s diligence exercise. Underwriters are aware that some diligence questions might not be answered at the time your written materials are produced (or, even at the time of the underwriting call), but you should not take that as an invitation to fail to close off as many diligence questions as possible prior to the underwriting conference call.
- Among the topics on which RWI policy underwriters most closely focus is whether it appears the deal parties will have obtained, at the time of the M&A deal’s closing, all consents to assignment or consents to change of control. And, real estate leases are among the target assets that most commonly require an assignment/change of control consent analysis and that result in consents needing to be obtained. Keep this in mind as you approach the underwriting call, because you likely will be called upon to update the underwriter on how the analysis and consent-gathering process is going.
- An RWI policy underwriter’s real estate inquiries often include a few questions that are a bit more “business” than “legal”, and if you are aware that they might be posed to your client, you can help your client prepare for how to answer them. Underwriters often ask whether anyone on the buy-side has conducted a site visit and, if so, what the visitor’s general sense of the condition of the leased premises was. Underwriters might also ask for a very brief overview of the general condition of the inventory (if applicable), equipment, and furniture within the leased space.
- As to environmental diligence, be prepared to offer the RWI policy underwriter a rationale for the scope of the diligence that was conducted or, on the other hand, why no such diligence was conducted. As you might imagine, most underwriters are compelled to significantly limit the potential hazardous materials-related exposure to the RWI policy. Moreover, the insurers for whom they underwrite policies almost certainly focus significantly upon such matters when they periodically audit the underwriter’s files. If you can professionally (even if only briefly, for instance in the case of a leased space that is clearly used only for typical office uses) answer the underwriter’s questions regarding environmental matters, it will probably be appreciated.
Real estate leasing lawyers who conduct a buy-side diligence exercise that is sensibly scoped to cover all the desired sell-side representations regarding leasing matters, who professionally describe that scope and the results of that exercise on the underwriting conference call, and who aid the M&A deal leader with responding to any follow-up questions and negotiating any resulting exclusions will significantly smooth the client’s path towards the closing of the M&A transaction and the inception of the desired RWI policy.