5 Essential Tips for Tailoring Your Diligence Plan to Secure R&W Insurance in Manufacturing Deals

It is no secret that a representations and warranties (R&W) insurer’s underwriting focus is informed by industry-specific risks and claims experience. For manufacturing businesses, aligning the buyer’s diligence plan and the insurer’s expectations is especially important given the need for advance planning and logistical coordination. Here are five (5) factors to consider when developing your due diligence plan to avoid deal delays and policy exclusions:

1. Environmental diligence: Ensure enough lead time for possible on-site assessments if the target owns its facilities. The scope of environmental due diligence for a manufacturing deal will depend on the nature of the operations and whether the sites are owned or leased. R&W insurers will typically ask for Phase I assessments for owned properties, particularly manufacturing sites. That may or may not mean the buyer needs to commission fresh Phase I studies. For example, if a Phase I study was done when the seller acquired the facility, it may be adequate depending on its recency and the type of operations since the acquisition. Alternatively, if the operations are not chemically intensive, R&W insurers may be willing to accept a desktop or another form of review by an environmental consultant. Note that if an on-site assessment is conducted, advance coordination with the target will be required, including agreeing on communications with employees who may need to participate in the assessment but may not be “under the tent” with respect to the broader transaction.
2. International operations: Coordinate with local counsel and set expectations with insurers. If the target company has operations outside the United States, it is important to align with the R&W insurer during the quote stage on the scope of international diligence needed and engage local counsel in material jurisdictions. What is deemed a “material” jurisdiction depends on factors such as employee headcount, revenue, type of operations, and the R&W policy’s retention amount. R&W insurers are often willing to accommodate written responses in lieu of live participation by local counsel in the underwriting call to help manage timing and cost concerns. If local counsel is less familiar with the R&W insurance process and coverage, it may be helpful to set expectations early regarding what is required for a written diligence summary.
3. Condition of assets and inventory: When conducting site visits, anticipate that insurers will ask about the condition of assets and inventory. R&W insurers in recent years have seen large claims related to machinery needing to be replaced or repaired (beyond normal wear and tear) and inventory-related issues. As such, R&W insurers are focused on the level of due diligence performed by the business team or its third-party advisors to inspect facilities, machinery, and inventory. We have generally found that site visits by the deal team and their verbal descriptions have been sufficient to satisfy a US underwriter, but this should be discussed upfront to avoid an unnecessary exclusion from the R&W policy. For inventory matters, insurers typically will ask about the condition and accounting treatment of inventory and may also require an inventory count, depending on the type and volume of inventory and the company’s inventory management practices.
4. Regulatory due diligence: Make sure third-party advisors have the requisite expertise. Some common areas of desired coverage for manufacturing deals include product liability, FDA and other regulatory compliance, global trade, and government contracts. When selecting transaction counsel and engaging other third-party advisors, consider whether they have the capabilities necessary to conduct due diligence for all desired areas of coverage.
5. Customer/supplier relationships: Have a plan in place for due diligence calls with key relationships. Unlike in some other industries, manufacturing targets may have individual customers and suppliers that are material to the target’s business. Loss of a key customer (i.e., recurring revenue) is among the largest areas of R&W claims, so R&W insurers usually flag customer calls as a requirement. We find it helpful to discuss during the quote stage what conversations will be had with the target’s key commercial relationships and whether those will be done prior to signing or prior to closing (if a split sign and close), especially for strategic transactions that can be more difficult to navigate. Lack of adequate diligence may result in a temporary or permanent exclusion in the policy.

While the above considerations may be of greater importance in manufacturing deals generally, we note that depending on the nature of the target’s specific manufacturing operations and workforce, certain labor and other matters may also require deeper diligence, and dealmakers should consult with their advisors on any deal-specific areas of heightened importance. It is also important to note that R&W insurers will still expect to see the same level of legal and other third-party due diligence with respect to other subject matters covered by the representations and warranties in the purchase agreement that are not industry-specific.

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.