Navigating representations and warranties insurance policies in Latin America

Introduction

Representations and warranties insurance (RWI) policies are designed to protect a party (most often the buyer) against breaches of the representations and warranties made by a seller in a purchase agreement.^[2] The policies often entirely replace indemnity escrows or sit alongside reduced escrows, thereby freeing sellers from an obligation to set aside a large amount of closing cash.

RWI policies are generally negotiated on a deal-to-deal basis between the buyer, the buyer’s counsel and the buyer’s insurance broker on the one hand, and the insurer on the other. The policy documents, and coverage is tailored to, the specifics of each transaction.

As RWI policies have become prevalent on deals in the United States and Europe, among other jurisdictions, dealmakers in Latin America have increasingly sought alternatives to traditional post-closing risk allocation methods. The quest for new and better transactional tools is driven by the growing complexity of transactions in the region, generational transitions within family-owned businesses, and the surge in post-covid-19 pandemic distressed divestments fuelling mergers and acquisitions (M&A).

These factors, and the region’s ongoing infrastructure development, have created fertile ground for the adoption of RWI policies in Latin America. Traditional tools, such as escrows and holdbacks, while effective in ensuring buyers have post-closing recourse against sellers, can prolong negotiations, involve costly intermediaries and sometimes complicate deals more than necessary. In contrast, RWI offers a streamlined, efficient alternative that aligns with the Latin American M&A market’s evolving needs.

This chapter examines the current state of the Latin American RWI market, the factors driving its expansion and some of the countervailing challenges that can complicate use of the product in the region. It also offers guidance for practitioners on how to effectively navigate the complexities of RWI in Latin America.

Current trends in Latin American RWI

Transactional risk insurance is poised to grow in the Latin American market. Initially, the limited availability of insurers willing to underwrite RWI policies in Latin America posed a significant barrier to the product’s wider adoption in the region: only a handful of global carriers were active in Latin America, leading to higher costs and limited policy options for dealmakers.

In recent years, insurer appetite for Latin American risks, and for underwriting deals governed by local laws, has increased significantly, driven by the region’s growing economic stability and the increasing maturity of its M&A landscape. At the time of writing, 11 carriers offer RWI policies covering Latin American risks in the US market, and 15 write Latin American risks out of the London market – a notable expansion from just a few years ago when the market was dominated by only a handful of players.^[3] Seven of those US-based carriers entered the market in the past two years, signalling a rising confidence in the region’s M&A potential and recognition of the demand for cutting-edge risk management solutions.

Sophisticated private equity funds, seeking to replicate the risk management tools that had become familiar in US and European deals, were the first to push for RWI in Latin American transactions;^[4] however, the current landscape has evolved to include strategic local buyers and sellers. These stakeholders have experienced the tangible benefits of RWI in their transactions and are integrating RWI into their expanding operations.^[5]

Pricing and coverage

The influx of new insurers into the Latin American market since 2022 has resulted in more competitive pricing and a broader scope of coverage on offer than ever before, making RWI both more accessible in Latin American transactions and better suited to the specific needs of the region. Rates have decreased largely because of two factors that have fomented competition among insurers: the slowdown in deal activity across the region beginning in the second half of 2022, which mirrored the global decrease in M&A, and the increasing number of insurers offering terms.^[6]

As in the United States, rates and coverage in Latin American deals are not ‘one size fits all’, and insurers consider several factors in formulating pricing and policy terms. These include the jurisdiction in which the target of the transaction sits, the nature and scope of the target’s operations, the target’s employee count and the choice of law governing the transaction. Carriers also consider the complexity of a transaction in preparing a quote: a deal involving a carve-out from a larger entity or a minority investment in a high-growth company may elicit different terms than a more basic majority stock acquisition.

Most RWI insurers operating in the region have the broadest appetite for transactions in Chile, Mexico, Colombia, Costa Rica and Peru – all countries that benefit from general legal and political stability. The deals that tend to attract the most competitive terms are for non-regulated assets, such as retail vendors and professional services firms, that are being acquired by experienced buyers opting to perform thorough due diligence exercises. On deals like these, insurers have started offering rates in Latin America that are only a few basis points higher than what a similar deal might cost in the United States.

The rates for Latin America generally range between a 2.7 per cent and 3 per cent rate on line.^[7] On the more complex end of the spectrum, rates tend to rise for deals involving products that are subject to stringent US or local regulatory oversight, assets with conditions that are difficult to assess and transactions in jurisdictions that are less familiar to the insurance market or prone to sudden changes in the status quo.

The recent tempering of M&A activity across Latin America has prompted insurers to reassess their risk evaluation strategies. With fewer large transactions in the market, insurers have had to adjust their focus and have started offering coverage for smaller-scale risks, which had previously been under-prioritised.

This new focus on smaller risks has been driven by the necessity to remain competitive and responsive to market needs. Despite the persistence of minimum premium and retention benchmarks, competitive pricing and coverage for deals with enterprise values under the US$100 million mark have become more accessible.^[8]

In the current climate, the most cost-effective deals for RWI – those that provide the most value for the insurance cost – are transactions with an enterprise value above US$40 million, assuming coverage is sought for approximately 10 per cent of the transaction’s total enterprise value. Underwriters with a presence in the region highlighted these thresholds as offering the optimal balance between risk and reward: deals this size create an efficient value-to-coverage ratio, making them appealing for underwriting purposes. ^[9]

An adaptive approach

Pricing, coverage terms and diligence requirements of transactional insurance coverage vary worldwide. US RWI coverage offerings often differ from those available in Europe, where the product is known as warranty and indemnity insurance (W&I). One way in which insurers in Latin America have adapted the product to the requirements of the Latin American region is to pull from both US and European-style coverage constructs to create a ‘best of’ model that addresses local issues and allows insurers to properly calibrate risks.

In this context, three main trends illustrate the innovative nature of Latin American RWI.

De minimis amounts

Insurers are increasingly incorporating de minimis amounts for certain categories of risk (e.g., labour issues, compliance or environmental exposures) into their policies. This means that, in addition to the general policy retention, which insured parties must erode with incurred loss before accessing policy proceeds, insured parties must incur losses exceeding a particular de minimis threshold for a given category of exposure before the insurer will pay a covered loss.^[10]

While European policies often apply a uniform de minimis amount across all claims based on the materiality thresholds set during due diligence, Latin American insurers take a more nuanced approach: they adjust these thresholds to address specific risks identified either during the underwriting process or at the initial deal evaluation stage.

Additionally, de minimis thresholds in Latin American transactions are typically calculated on a claim-by-claim basis rather than through the aggregation of multiple claims with a similar pattern. This approach is intended to provide coverage for recurring issues that arise in day-to-day operations while avoiding exclusions for atypical matters or amounts that fall outside the normal course of business and remain unknown to the insured.

Retentions

In the realm of complex risk assessments (e.g., evaluating the condition of a business’s assets or addressing product liability exposures), insurers are increasingly deploying specific retentions in place of outright exclusions at the outset. These specific retentions are stand-alone retentions larger than, or stacked with, the general retention for risk categories that may not otherwise be adequately insured or insurable.

Specific retentions in the United States are often employed where a target company is or may be uninsured or uninsured for a given risk. In Latin America, rather than being primarily driven by the adequacy of underlying insurance, specific retentions serve as a strategic mitigation tool for risks that would, absent the extra buffer of the retention, likely be excluded from the start. This approach not only underscores the creativity and adaptability inherent in the Latin American market but also demonstrates how the region’s standards for RWI policies are evolving with a distinct flexibility not as commonly found in more mature markets.

Stapled policies

Parties in Latin America are increasingly embracing stapled policies, which have long been used in European deals but are much less common in the United States. With a staple, the seller kick-starts the RWI marketing and, in some cases, the policy negotiation and underwriting process, and then passes it along to the buyer that will eventually be the named insured party under the policy.

In a ‘soft staple’ (also known as a ‘seller flip’), the seller’s broker markets the transaction to insurers, and the seller then shares the market feedback with the buyer, which can then determine how to proceed with the insurance process. In a ‘hard staple’, the seller selects the insurer and begins underwriting on the sell-side before passing an advanced policy to the buyer for completion.

The hard-staple approach is more common in larger or more complex transactions, where the sellers themselves have undertaken thorough vendor due diligence. Hard staples allow sellers to manage the process more efficiently and gives them insight into the ultimate scope of coverage.

While soft staples are occasionally used in US transactions, stapling in general is much more common in European transactions. The adoption of stapling by the Latin American market is another example of how lawyers, insured parties and carriers in the region are pulling from existing approaches in other markets to create the product best suited to the Latin American market’s needs.

This bespoke approach not only demonstrates the market’s capacity for innovation but also its ability to navigate the unique and often complex legal and regulatory landscapes of Latin America. By customising solutions to meet the distinct challenges of each deal, RWI policies in Latin America offer a level of flexibility and protection that is closely aligned with the needs of both insurers and their clients.

Country-specific considerations

RWI insurers typically require buyers to undertake a comprehensive due diligence process that is meticulously tailored to address the specific risks, legal frameworks and business practices unique to each target, industry and country. The insurers then ‘piggyback’ on the buyer’s diligence to identify areas of specific exposure or potential material liability. Although there are commonalities across the region, certain countries present distinct challenges that necessitate a more focused and specialised review by insurers.

For instance, corporate authorisation and governance compliance reviews may be broadly standardised, and, despite each country’s unique corporate framework, underwriters often adopt a global approach to these matters; however, when it comes to financial statements and tax due diligence, Brazil, for example, stands out because of its extraordinarily complex tax system and financial regulations, which demand a deeper, more nuanced analysis. Underwriters must, therefore, apply a rigorous, country-specific approach to ensure that all relevant risks are thoroughly assessed and mitigated.

This tailored approach requires that the buyers undertake a customised due diligence review to address country-specific concerns, which is essential for securing broad RWI coverage. By accurately assessing each risk profile and determining the appropriate coverage terms, focused diligence reviews often result in broader coverage. In regions such as Latin America, where political, economic and regulatory landscapes can vary significantly from country to country, this level of scrutiny is critical for successful deal execution and risk management. Below are some key focus areas of various Latin American jurisdictions that will help to highlight the stress points that must be addressed for optimal coverage.

Brazil

Brazil’s tax system is highly complex, with multiple layers of taxes at federal, state and municipal levels. These tax regimes are constantly evolving, with an average of 35 new tax rules every day.^[11] Due diligence on deals involving RWI policies must, therefore, include a thorough analysis of the target’s historical tax filings, exposure to audits and compliance with Brazil’s intricate tax regulations.

Although recent tax reform has simplified the application of consumption taxes, allowing RWI carriers to underwrite those risks rather than exclude them at the outset,^[12] assessing these risks remains complicated.

Further, carriers will closely review diligence regarding compliance with the US Foreign Corrupt Practices Act^[13] and its newly enacted complement, the Foreign Extortion Prevention Act, as well as the Brazilian Anti-Corruption Law.^[14] In particular, enforcement of penalties under the Anti-Corruption Law can be of concern as the law may extend beyond a target directly involved in corruption to hold the ultimate buyer liable.^[15]

Although anti-money laundering, counterterrorism finance and corruption representations are often excluded from deals across the region, underwriters still require buyers to conduct at least a customary review to avoid adding further coverage restrictions on representations regarding undisclosed liabilities and compliance with laws.

Chile

Despite Chile’s long-standing reputation for regulatory stability, recent political shifts have prompted underwriters to intensify their scrutiny of Chilean risks, particularly in the mining and energy sectors.^[16] Because Chilean law imposes restrictions on private ownership within these sectors, underwriters are now demanding more rigorous due diligence to ensure compliance with evolving regulations related to concession rights and mineral lease agreements with the Chilean government.^[17]

In addition, employment law-related diligence, including analysis of overtime pay and benefits, has also become increasingly critical following the introduction of Law No. 21,561 in April 2024, which mandates a phased reduction of the standard working week to 40 hours by May 2028.^[18] This progressive shift is expected to significantly alter the operational landscape for all Chilean companies, potentially leading to a surge in compliance-related claims as businesses adapt to the new labour regulations. The gradual implementation of these changes underscores the importance of proactive compliance strategies to mitigate the risk of labour disputes and ensure adherence to the evolving legal framework.

Colombia

Colombia is one of the region’s most attractive investment centres, owing to its abundance of natural resources and a fast-growing middle class. Although investment has slowed since President Gustavo Petro took office in August 2022,^[19] the country is still a leading economy.

However, growing concerns with Petro’s administration pushing the concept of domestic sovereignty in key economic sectors has created high levels of uncertainty for underwriters.^[20] A blanket exclusion for government takings has, therefore, been a standard on highly regulated sectors, such as energy, ports and airports, concessions and mining.

Further, the robust enforcement of anti-money laundering regulations has intensified scrutiny in those areas, often leading to exclusion at the outset for all related matters. A recent ruling by the Superintendence of Companies, which is responsible for supervising commercial companies in Colombia, imposed a US$2 million fine on a buyer who acquired a company that had previously been involved in corrupt practices.^[21] This decision has underscored the necessity for underwriters to rigorously review buyers’ corruption-related due diligence.

Additionally, underwriters are increasingly attentive to ensuring compliance with Law No. 1778 of 2016 and its associated regulatory requirements, which govern the actions, steps and programmes of applicable companies to prevent transnational bribery and other forms of corruption.

Mexico

In 2023, Mexico emerged as the United States’ largest trading partner in goods.^[22] Today, Mexico stands as the second-largest export market for US goods, reflecting the deepening economic ties and the critical role Mexico plays in the broader North American trade landscape.^[23]

Underwriters of Mexican risks are primarily focused on compliance with trade and customs laws, which can be major areas of risk for acquirers of Mexican targets. The primary concern regarding trade laws revolves around compliance with the ‘digital waybill complement’ for various goods shipments. This regulation mandates the inclusion of an excessive amount of data points for shipments across all transportation modes – rail, truck, air and maritime^[24] – many of which are often unknown at the start of a shipment. This creates significant challenges and potential stress points that could lead to compliance issues and claims. The complexity and uncertainty surrounding the required information make this an area of heightened risk for businesses operating in Mexico.

Argentina and Peru

Insurers’ appetites have shifted in the past two years for risks in Argentina and Peru, albeit in opposite directions. Political upheaval at the end of 2022 led many underwriters to adopt a more conservative stance with respect to Peruvian targets, reflecting concerns about the country’s stability and the increased risk of government intervention in transactions. ^[25] That conservatism is evidenced in many RWI policies’ broad exclusions for permanent government takings – a measure designed to mitigate the risk to insurers of expropriation or similar government actions.

While some carriers have scaled back their presence in Peru, the market has demonstrated resilience, with economic conditions remaining stable despite political challenges. There has been a gradual recovery in underwriting appetite, though insurers continue to evaluate Peruvian risks on a case-by-case basis, with potential for increased capacity if stability proves to be sustained.

Conversely, Argentina has seen a more positive shift in underwriters’ willingness to engage, driven by recent improvements in the political landscape there;^[26] however, significant underwriting challenges persist in Argentina because of the country’s stringent capital controls. These controls pose considerable difficulties for companies attempting to access the foreign exchange market, manage debt and repatriate funds. These financial restrictions have made it challenging to accurately value businesses, leading to increased scrutiny of foreign exchange activities during the due diligence process for each target company. These factors underscore the need for careful consideration of both political and financial risks involved in structuring deals in Argentina and Peru.

Navigating the complexities of RWI coverage for M&A transactions in Latin America requires a keen understanding of the unique challenges and regulatory landscapes specific to each country. While certain risks may be addressed through standardised approaches, others demand a more nuanced, country-specific due diligence process to ensure comprehensive coverage. By tailoring due diligence to address these jurisdictional particularities, parties can secure broader and more effective RWI coverage, ultimately facilitating successful deal execution across this diverse and dynamic region.

Cases

Peruvian buyer acquires Brazilian entity

A Peruvian strategic corporation in the frozen food industry aimed to expand its operations by acquiring a Brazilian entity with similar operations across multiple jurisdictions in the Latin American region. The acquisition would significantly bolster the buyer’s presence in the Latin American market. The transaction documents were governed by US law rather than Peruvian or Brazilian law.

To mitigate the risks associated with compliance with multiple and varying legal systems, the Peruvian buyer opted for RWI. The RWI policy played a pivotal role in the smooth execution of the transaction: it provided a safety net that protected the buyer from the potentially substantial financial losses that could have arisen from compliance issues or hidden operational flaws within the Brazilian entity while avoiding a complicated discussion with the buyer on recourse and indemnity. Furthermore, the use of an RWI policy facilitated a quicker closing process by aligning the parties’ interests regarding risk and liability.

This case is a prime example of how RWI can successfully bridge the gap between seller appetite for a clean exit and operational risks arising from different legal systems, providing a robust framework for cross-border transactions.

US buyer acquires Chilean technology provider

In this transaction, a US-based firm sought to acquire a Chilean technology provider, with the deal governed by Chilean law. The target company specialised in cutting-edge technology for cloud and data storage solutions, making the deal highly attractive but also susceptible to significant intellectual property, data privacy and compliance risks.

Recognising these risks, as well as concerns regarding the adequacy and availability of effective remedies for intellectual property violations under Chilean law,^[27] the US buyer used RWI to protect against any inaccuracies in the seller’s representations. The policy was tailored to address concerns regarding adequate coverage for intellectual property issues as well as jurisdictional complexities in the form of differentiated formality requirements for the transfer of shares. The underwriters were able to provide coverage under the Chilean law agreement without significant exclusions from coverage because of the specific knowledge provided by their local counsel. The successful use of RWI in this deal highlights its effectiveness in managing sector-specific risks and aligning international legal considerations.

Mexican excess coverage

The first excess W&I insurance programme for a Mexican insured party was placed in 2024, which involved two carriers and a total of US$50 million in insurance limits. The capital market restrictions in Mexico meant that only insurers writing the risk on Mexican-admitted paper could work on the deal, which limited the universe of potential underwriters. The US$350 million acquisition of a gas-fired power generation plant in Mexico marked a substantial investment into a growing market by an established infrastructure fund.

Conclusions

The adoption of RWI in Latin America is rapidly transforming the region’s M&A landscape. The growing complexity of transactions, coupled with the evolving sophistication of both local dealmakers and insurers, has paved the way for RWI becoming an indispensable tool for managing transactional risks. The increasing availability of competitive pricing and tailored coverage options reflects the region’s maturation in the global M&A market, making RWI more accessible and relevant than ever before.

The diverse applications of RWI – from facilitating smoother transitions in family-owned businesses to streamlining infrastructure deals and navigating complex cross-border transactions – demonstrate its utility in addressing the unique challenges of the Latin American market. As insurers continue to refine their offerings in response to local legal nuances and deal dynamics, RWI is expected to further solidify its role as a standard component of M&A transactions in the region.

Ultimately, the evolution of RWI in Latin America is not just a reflection of the region’s economic growth but also a testament to the adaptability and innovation of its business environment. As more dealmakers recognise the value of RWI in mitigating risks and facilitating successful transactions, its adoption will likely continue to expand, further integrating this sophisticated risk management tool into the fabric of Latin American M&A activity.

Endnotes