Warranty and Indemnity Insurance has become a staple policy in Mergers and Acquisitions transactions. We take a closer look at the different types of W&I policy and the benefits to both buyers and sellers.
What is Warranty and Indemnity Insurance (W&I)?
Warranty and Indemnity insurance is not new, but it has become increasingly popular in recent years within the context of Mergers and Acquisitions (M&A) transactions, particularly in Asia.
This type of policy covers a buyer’s or a seller’s liability in the case of a breach of warranties by the seller in a sale purchase agreement (SPA). Warranties are representations and promises made by the seller concerning the quality, condition and legality of the company being sold. Indemnities are promises by the seller to compensate the buyer for any losses that may arise as a result of a breach of the seller’s warranties.
Liability is a key point of negotiation in M&A deals and both parties will aim to mitigate financial risk in the event of warranty claims.
Buyers seek robust financial safeguards that they won’t be liable for claims whereas vendors want a seamless exist strategy with no financial fallout for them once the deal is signed. Finding a delicate balance that protects both parties is tricky and often leads to a standoff during negotiations.
Warranty and Indemnity insurance provides a solution to this dilemma.
The different types of W&I Insurance
Buy-side insurance is the most common type of W&I policy. It protects a buyer from losses arising in connection with the breach of certain warranties and/or indemnities in the SPA after completion. The premium payment will form part of the negotiation of the SPA and may be paid by the buyer or the seller. Once the SPA is signed, the seller is exonerated from any responsibility for breach of warranties or indemnities, subject to any policy exclusions.
Sell-side insurance protects the seller if the buyer makes a claim against them for any losses arising in connection with the breach of certain warranties and/or indemnities in the SPA. It is usually paid for by the seller.
Sell-side flip insurance is often used in a competitive sale process. The seller will negotiate coverage terms and price with an insurance broker and after the bid process, the broker ‘flips’ to work for the successful bidder and is remunerated by them. This can expedite the transaction process and enhance the attractiveness of the deal to potential buyers, reducing due diligence concerns and streamlining negotiations for a quicker transaction closure.
The information in this guide concentrates on buy-side policies, the most common type of W&I cover.
Benefits of W&I insurance
There are certain benefits of W&I insurance to both sides in a M&A deal.
W&I insurance facilitates the deal by removing deal-breaking risks from the transaction. These are borne by the W&I insurer. It can also help maintain a relationship between buyers and sellers. This can be particularly important if management sellers remain with the business post-completion. A third party (the insurer) becomes responsible for any claims that would otherwise be made against the seller.
Benefits of W&I insurance to the buyer
W&I insurance offers numerous advantages to a buyer. A W&I policy:
- Transfers financial risk to the insurer
- Enhances the attractiveness of a bid in a competitive sale process
- Improves scrutiny with additional due diligence from the insurer
- Expedites negotiations, acquisition of finance and deal closure
- Accelerates resolution of claims
- Preserves post-transaction relationships
- Avoids problems due to seller’s (in)solvency
- Enables tailored protection
Benefits of W&I insurance to the seller
W&I insurance also provides several advantages to a seller. A W&I policy:
- Facilitates a clean exit
- Minimises post-sale liability
- Eliminates the need to hold a portion of the sale proceeds in escrow to cover potential claims
- Offers financial protection against potential future claims
- Enhances the attractiveness of a deal and facilitates smoother negotiations
- Expedites the sale process
Key factors shaping a comprehensive W&I insurance policy
The specifics of W&I insurance vary enormously based on the transaction structure and the negotiations between the parties involved. These are the main considerations when negotiating a contract.
Accurate risk assessment
W&I insurance is a not substitute for robust due diligence. A buyer should ensure they understand the nature of the business including potential liabilities and risks. This will help in customising appropriate W&I coverage. Indeed, an insurer will insist upon proof of adequate due diligence including include full disclosure of all material documents relevant to the business, a detailed disclosure letter, a formal q and a process and access to a comprehensive dataroom. The insurer may make additional demands concerning certain warranties to protect their own interests such as a succinct report to enable underwriters to quickly assess the transaction and form conclusions regarding exclusions.
Clear and comprehensive warranties
The policy should include clear and comprehensive warranties that align with the representations made in the SPA. This helps to avoid ambiguity and ensures the coverage adequately reflects the SPA’s terms. These should be outlined in a warranty spreadsheet which serves as a structured reference point for both the buyer and seller during negotiations and allows the buyer to evaluate the risks associated with the transaction systematically.
Policy exclusions
Policy exclusions should be identified and clearly defined to avoid misunderstandings and ensure transparency regarding what is not covered by the insurance. The exclusions will inevitably leave certain gaps in liability to be negotiated between buyer and seller. Some standard policy exclusions include:
- Known issues undisclosed by the seller
- General price adjustments
- Forward-looking statements and future financial projections
- Fraud
- Criminal fines and penalties
- Tax liabilities
- Environmental liabilities and breaches
- Employee claims and benefits
- Regulatory compliance
- Intellectual Property (IP) risks
- Pre-existing litigation
- Warranties outside of agreed scope
- Cyber breaches
- Excluded industries or activities deemed too risky but the insurer
Financial limits and deductibles
Setting appropriate financial limits and deductibles is essential. An excess will usually apply, and sellers should ensure this is linked to the maximum liability cap under the SPA. Determining the maximum coverage amount and the deductible helps manage the financial risk and ensures the policy remains cost-effective.
Insurer reputation
Choosing a reputable and reliable insurer is key. Assessing the insurer’s track record, financial stability, and expertise in handling claims is essential to ensure confidence in the policy’s execution.
Compliance
Ensuring the policy meets legal standards and regulatory guidelines helps avoid potential disputes and ensures the policy’s validity.
Seller protection
In a standard Sale and Purchase Agreement (SPA), sellers offer warranties that guarantee the accuracy of business information. Breaches in these warranties entitle the buyer to seek compensation directly from the seller. In transactions involving Warranty and Indemnity (W&I) insurance, the SPA will be structured so that primary recourse is through claims under the W&I policy. This prevents the buyer from individually pursuing sellers for breaches covered by the insurance policy. Sellers should be cautious if buyers attempt to weaken this obligation by seeking recovery from the insurer on a ‘best endeavours’ basis.
Post-closure support and claims handling
Establishing a clear process for handling claims post-closure is crucial. A well-defined mechanism for claims submission, assessment, and resolution supports a smoother post-transaction phase.
Professional advice for tailored W&I insurance
W&I insurance is a bespoke product and policies are extremely complex. In order to navigate these complexities and understand the full scope of coverage including limitations and exclusions, it is imperative to work with a specialist broker.
If you are negotiating an M&A transaction, talk to us. Whether you are buying or selling, we will leverage our considerable expertise to match identified risks with suitable insurance providers and policies. We can gather quotes and proposals and explain the coverage offered, premiums, terms, conditions and any exclusions associated with each policy.
Working with Continuum to find the right W&I policy will help mitigate the risks associated with your M&A transaction, giving you peace of mind.
