Introduction
Leaving aside commercial issues and discussions on the consideration for the target shares, negotiating contractual representations and warranties and indemnification structures is often the most difficult and time-consuming part of an M&A transaction. These negotiations usually lead to escrow or holdback arrangements through which the buyer aims to secure itself against potential risks identified during its due diligence review. Even where the seller wishes to avoid any retention or delay of the consideration, it frequently ends up facing an escrow or holdback request.
An escrow generally requires the involvement of a third party, the escrow agent. Negotiating the escrow agreement therefore delays signing further, and the parties may suffer deal fatigue as their enthusiasm for the transaction declines with every obstacle. In addition, an escrow sometimes gives its beneficiaries insufficient protection, either because the escrowed funds are not enough or because litigation may be needed to obtain them. For these reasons, M&A practitioners often look for alternative solutions.
Representations and Warranties Insurance
An insurance product, namely M&A insurance (or representations and warranties insurance), has recently become available as an alternative for both sellers and buyers. It provides cover against the risks arising from the seller's breach of contractual representations and warranties.
In practice, there are two types of representations and warranties policy, seller-side and buyer-side. Seller-side policies protect the seller directly against representations and warranties claims brought by the buyer, much like a third-party liability insurance policy. Buyer-side policies directly compensate the buyer for losses suffered as a result of the seller's breach of representations and warranties, much like a first-party liability insurance policy.
Although the two types of policy share many features, they differ in certain key respects. Seller-side policies usually reflect the liability caps and limitation periods set out in the share purchase agreement, whereas buyer-side policies are used for losses exceeding those contractual caps and falling outside the listed limitations of liability.
Position Under Turkish Law
The Insurance Law is the principal legislation governing insurance activities in Türkiye. It regulates insurance products as well as the establishment, management, operation, supervision and audit of insurance and reinsurance companies, agencies and brokers. The Insurance Law also sets out the framework for the Turkish insurance sector, and its principles are elaborated in secondary legislation. The Communiqué on Insurance Branches lists the insurance branches in which an insurance company may operate and requires a licence for each branch. Turkish insurers may not issue policies for insurance products that are not expressly listed in the Communiqué.
Representations and warranties insurance is a new product in Türkiye and is not yet regulated as a branch of insurance under the Communiqué. Turkish insurers therefore cannot issue this type of policy directly. Some scholars and insurance practitioners consider that representations and warranties insurance falls within general liability insurance. Even so, given the lack of a legal basis and the Treasury's silence on whether the product is permissible, Turkish insurers choose not to issue policies covering sellers' representations and warranties.
M&A practitioners and insurance companies expect that local market demand will lead the Treasury to focus on this product and create a legislative basis allowing Turkish insurers to issue such policies. For now, representations and warranties insurance can be obtained in Türkiye through foreign insurance companies, although this is generally not cost-effective. The product simplifies indemnification procedures for both parties, but the gap between cost and risk needs to be balanced. Only then will insurers be able to take the place of escrow agents.