Warranty & Indemnity Insurance in M&A: A Summary
The use of warranty & indemnity insurance (otherwise known as W&I insurance, or W&I) in corporate M&A has become steadily more prevalent in recent years. This article will outline what W&I insurance is, summarise the circumstances in which it is most commonly used, and provide a brief overview of the process involved in putting a W&I policy in place.
- What is warranty & indemnity insurance?
In an M&A transaction, a seller is, in most cases, required to provide commercial and tax warranties to the buyer. Warranties are statements of fact about the business as at completion, and they provide a buyer with a contractual right to bring a warranty claim against the seller should the buyer suffer a loss after the acquisition as a result of any of the warranties being untrue. As a seller is allowed to disclose against the warranties prior to completion, the warranties can also act as a way of gathering information about the target, and substantiating what it has already discovered via due diligence.
As a result, a buyer will usually try and obtain as extensive a list of warranties as is possible, whilst a seller will inevitably wish to limit this list and build limitations on liability into the relevant transaction document(s). This difference in outlook and risk allocation can lead to discord between the parties during negotiations, and in some cases, where the position of the parties is very far apart, can lead to transactions being aborted.
Warranty and indemnity insurance is a specialist insurance product designed to provide cover against financial loss that may arise from a breach of warranty or tax indemnity in the context of a corporate M&A transaction. It can therefore be a very useful tool in seeking to align a buyer and seller's expectations on post-acquisition liability.
- When is W&I insurance most commonly used?
W&I policies may either be buy-side or sell-side. Whilst W&I insurance was initially marketed as a sell-side product to provide sellers with some measure of comfort in the context of an exit, increasingly we are seeing policies being taken out by the buyer. This doesn’t necessarily mean that the buyer will be responsible for paying the premium, which is usually a matter of negotiation between the parties.
A buyer may want to take out the policy in the following circumstances:
- Where the seller makes it a condition of the deal
- In a competitive auction process a buyer may offer to put in place a W&I policy to differentiate it from other bidders (though, given the recent popularity in W&I insurance, this is becoming less of a differentiating factor)
- In circumstances where, for whatever reason, recourse against the seller in the transaction documents is limited
- Where the seller remains employed by or engaged by the business after acquisition, and the buyer therefore wants to maintain a good relationship
There is also a practical reason as to why it makes sense for the buyer to take out the policy instead of a seller. Where the buyer is the insured party, it can make a claim as soon as the breach of warranty or indemnity occurs, whereas if the seller takes out the policy, the buyer is required to make its claim against the seller first, and it is the seller who then makes a claim against the insurance in respect of the breach.
Notwithstanding the prevalence of buy-side policies as outlined above, sellers may still want to take out a policy for the following reasons:
- Where the sellers are individuals, having a W&I policy in place can provide comfort as to potential liability post acquisition and can allow sellers to use sale proceeds immediately
- Where a buyer has refused to use W&I insurance or fund the policy
- Where the seller is to be wound up post acquisition
- Overview of process
here are now a significant number of specialist M&A insurance brokers who can advise on, and manage, the provision of W&I insurance. Whilst such insurers are now well versed on the processes involved, it can typically take anywhere from 2 to 3 weeks to put a policy on risk, and so the party taking out the insurance is well advised to start discussions with its broker at an early stage of the transaction.
The cost of the insurance is typically made up of a premium payable when the policy is put on risk, plus insurance premium tax, which for a UK insured is 12% of the premium. The premium can vary depending on the transaction, but typically is somewhere between 0.9% and 1.5% of the total coverage.
The insurer and its lawyers will need to review all of the due diligence reports that have been prepared for and on behalf of the buyer, together with the key transaction documents, including the relevant sale agreement and the seller's disclosure letter. They may also ask additional questions of the buyer's due diligence team either via correspondence, or on an underwriting call. The purpose of this is so that an insurer can obtain comfort from the due diligence team as to the level of due diligence undertaken and the risks identified.
The insurer will then issue a draft policy to be reviewed by the potential insured. It is important to note that not all losses will be recoverable under a W&I policy, and not all warranties will be covered by insurance. Different insurers will exclude different risks, but typical exclusions include known risks, certain tax risks such as transfer pricing and secondary tax liabilities, pensions and claims arising from fraud or dishonestly.In addition, the limitations on the policy will typically mirror the limitations agreed in the transaction documents, including the de minimis limit, and, as with any insurance, the responsibility will fall on the insured to ensure that all material information was provided to the insurer prior to it going on risk, and to prove that any claim falls within the scope of the policy.
Once the policy wording is agreed it will usually be on risk from completion for the limitation time period outlined in the SPA, although it is possible to negotiate a different time period in the policy.
In conclusion, depending on the deal parameters, and provided that the parties understand the scope of the policy exclusions and that it is not a complete solution to all risk, W&I insurance can be a helpful product with which to manage risk between the parties.
*This information is for guidance purposes only and does not constitute, nor should be regarded, as a substitute for taking legal advice that is tailored to your circumstances.