When a Reps and Warranties Exclusion Became a Real Bill

The situation

Soo-jin, Senthil and Abirami had run the day-to-day operations of a mechanical contracting business in Peterborough for years before its founder decided to retire. Senthil was a licensed plumber who had moved up through the company's field crews into running operations. Soo-jin had spent a decade as an insurance adjuster before joining the business on the administrative side, and had a habit of reading policy wording line by line that would matter more than anyone expected. Abirami managed the office and the client relationships that kept the business's commercial contracts renewing. Together they structured a management buyout, valued at roughly $22 million, using a mix of personal capital, a vendor take-back loan from the retiring founder, and third-party acquisition financing.

Our team was engaged to act for the buying group on the purchase agreement, the closing mechanics, and the insurance structure that would sit behind the deal's promises. In a business sale, the seller makes a long list of representations and warranties: that the financial statements are accurate, that employees are properly classified, that there is no undisclosed litigation, and dozens more. If any of those promises turns out to be false, the buyer normally has a right to claim against the seller for the resulting loss. The problem is collection. A retiring founder does not want years of exposure hanging over their retirement, and often does not want a large chunk of the sale proceeds held back in escrow, an account holding funds in reserve, to guarantee it.

What the review found

To solve that tension, the deal used representations and warranties insurance, a policy purchased in connection with a business sale that pays the buyer directly for a breach of the seller's promises, instead of the buyer having to chase the seller personally. It let the founder walk away with the bulk of the sale proceeds at closing, while giving Soo-jin, Senthil and Abirami a solvent party, the insurer, to claim against if something in the business turned out to be different from what was represented. Deals in this size range use this kind of policy often enough that insurers have become sophisticated about pricing it, and equally sophisticated about excluding what they will not cover.

During due diligence, our review of the company's employment practices flagged a real issue. A group of field technicians had, for a period of time, been treated as independent contractors rather than employees for scheduling and overtime purposes, even though the nature of their work and supervision looked much more like employment. Under the Employment Standards Act, 2000, misclassifying employees as contractors can leave a business exposed to claims for unpaid overtime, vacation pay and other entitlements going back over the period of misclassification. We disclosed this finding formally to the insurer as part of underwriting.

The insurer's response was predictable but still consequential: it would not cover a risk it already knew about. The policy came back with a specific exclusion carving out any claim connected to the historical classification of field technicians. That is standard practice for reps and warranties insurance generally, coverage responds to the unknown, not to a problem already on the table, but it meant the buying group would close with a real gap. If the classification issue ever turned into an actual claim, the insurance policy that was supposed to be their safety net would not pay a cent toward it.

What we did

1. Treated the exclusion as a negotiating fact, not a dead end. Once it was clear the insurer would carve out the classification issue, we went back to the purchase agreement itself rather than trying to argue with the insurer. The seller still had to stand behind the risks the policy would not cover.
2. Negotiated a special indemnity tied specifically to the excluded issue. Alongside the general representations, we built a standalone indemnity, a separate contractual promise to compensate for a defined loss, that applied only to claims arising from the technician classification history, with its own survival period of eighteen months and its own dollar cap.
3. Secured a holdback to fund it. Rather than relying on the founder's personal covenant, we negotiated a closing holdback of roughly $650,000 from the sale proceeds, placed with a third-party escrow agent and released to the founder only if no classification claim materialized within the indemnity period.
4. Built a clear notice mechanism. The agreement set out exactly how and when the buying group had to notify the founder of a claim to preserve their indemnity rights, a deadline we tracked carefully once the deal closed, since missing it would have forfeited the protection we had just negotiated.
5. Advised on remediation going forward. Separately from the indemnity, we recommended the buying group correct the classification practice for current technicians immediately after closing, so the exposure was contained to the historical period rather than continuing to grow.

The outcome

About eleven months after closing, a group of former and current field technicians brought a claim against the company for unpaid overtime and vacation pay tied to the period when they had been treated as contractors. The total claimed came to roughly $900,000, once back wages, statutory vacation pay and interest were added together, well above what anyone had modelled when the deal was priced.

The reps and warranties insurer declined coverage, exactly as the exclusion said it would. That left the special indemnity as the buying group's only real recourse, and it was worth what the negotiation had put into it. The $650,000 holdback was still sitting in escrow, and the notice had gone out within the required window, so the founder could not argue the claim was out of time.

The shortfall was roughly $250,000 above the holdback amount, more than the cap the founder had originally agreed to absorb. Rather than litigate the gap, both sides negotiated. The founder agreed to contribute an additional roughly $150,000 beyond the original cap, in recognition that the classification practice had existed on their watch and the escrow amount had been estimated conservatively. Soo-jin, Senthil and Abirami accepted responsibility for the remaining roughly $100,000, reflecting that they had operated the business, and known about the classification issue, for nearly a year before the claim arrived. Combined with the $650,000 holdback, the $900,000 claim was fully funded: $800,000 from the founder and $100,000 absorbed by the buying group.

It was not the clean outcome anyone hoped for at closing, but it was a functional one. The special indemnity did exactly what it was built to do once the insurance would not, and the notice discipline the buying group kept up meant the protection was still available when they needed it, rather than lost to a missed deadline.

Soo-jin, whose years reading insurance policy wording had made her the one who first pressed to see the exact language of the exclusion, later pushed the buying group to review the classification of every field role again as the business grew, rather than treating the one-time remediation as the end of the exercise. The claim also became a reference point internally: when the company later brought on new supervisors, onboarding included a specific walkthrough of how scheduling and control over a worker's day, not just the label on a contract, determines whether that person is legally an employee. The deal's lesson outlasted the deal itself.

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