Warranties and indemnities generally take up considerable negotiation time in sale contract negotiations, with buyers' and sellers' expectations of post-completion liabilities often misaligned. This is where warranty and indemnity (W&I) insurance may assist - offering the parties an alternative method of mitigating their respective risks in respect of breaches of warranties and indemnities contained in a sale contract.
W&I insurance has gained traction in real estate transactions in recent years and with greater understanding of this risk mitigation tool in the market, its use will likely grow as buyers and sellers alike come to realise the benefits of using W&I insurance in their transactions.
This alert provides an overview of W&I insurance and sets out the key issues that parties should consider when deciding whether to use W&I insurance in their next real estate transaction.
What is W&I insurance?
W&I insurance is an insurance policy that covers losses arising from a breach of warranties and indemnities in a sale contract. Depending on who is seeking the benefit of the policy, W&I insurance can be structured to indemnify either the buyer under a buyer-side policy or the seller under a seller-side policy.
- agrees under the sale contract that it will have no recourse (subject to agreed exceptions) in respect of breach of the vendor warranties contained in the sale contract; and
- is insured for losses it suffers as a result of a breach of vendor warranties (subject to agreed limitations) given under the sale contract.
Under this type of policy, the buyer is able to claim directly against the insurer for any warranty breaches.
Note: Buyer-side policies are more common and comprise the substantial majority of the W&I insurance policies written in the Australian market.
The seller providing warranties is insured for any losses (including costs incurred in defending or investigating the claim) it suffers as a result of the buyer bringing a valid claim for breach of warranties (subject to agreed limitations) under a sale contract. Under this type of policy, the buyer makes a claim against the seller for any warranty breaches who then makes a claim against the insurer.
Note: Seller-side policies may be useful where the buyer is unwilling to accept W&I products. If the policy does not cover the relevant loss, however, then the seller is still at risk.
What are the key benefits of W&I insurance?
W&I insurance is an attractive risk mitigation strategy in real estate transactions as it assigns risk to a third party insurer.
The following table summarises the key benefits of W&I insurance for buyers and sellers:
|For buyers||Benefits include:
|For sellers||Benefits include:
W&I insurance is particularly attractive where the seller is in administration or receivership and as a result, not in a position to provide any warranties or indemnities on a recourse basis in a sale transaction. Such sellers are effectively selling on an "as is where is" basis with limited or no contractual protection able to be offered to the purchaser.
Is W&I Insurance a suitable tool in your next real estate transaction?
To determine whether W&I insurance should be used in your next real estate transaction, it is important to consider the following items.
|Coverage||What is covered?
W&I policies generally cover the losses arising from the breach of warranties contained in a sale contract. Ideally, the policy will provide 'back-to-back' cover against sale contract warranties. It is important to carefully consider the wording of a W&I insurance policy to minimise the mismatch between the policy's coverage and the warranties contained in a sale contract.
What is usually not covered?
W&I policies will not necessarily match the warranties contained in a sale contract and there are certain carve outs which are generally excluded from W&I policies, including:
|Timing||Parties must consider the deal timeline and factor into account the time required to negotiate and obtain a W&I insurance policy (noting that the W&I insurance policy is customarily negotiated and signed contemporaneously with the sale contract).
What is the process involved?
The W&I insurance process involves the following stages:
|Due diligence||How does due diligence affect W&I policies? The prospective insured must provide to the insurer legal due diligence reports and other specialist reports (on a non-reliance basis) and data room access so that the insurer can carry out its own due diligence. Good quality due diligence information and advisers who have the expertise that insurers would expect for the transaction are paramount. Prior to finalising the W&I policy (typically 2-3 days prior to signing), an underwriting call will take place whereby the prospective insured party's deal team will answer questions provided by the insurer. It is important to ensure the right deal team members are on the call (e.g., legal advisers, tax advisers, financial advisers and key deal team members) to be able to provide to the insurer comfort as to the overall scope of due diligence and any issues identified in due diligence. A legal team that is familiar with and understands what the insurer is expecting will assist in solving issues with the insurer with minimal extra due diligence required.|
|Costs||How much is the premium?
The W&I insurance premium is a one-off cost that is calculated as a percentage of the total amount insured (as opposed to deal value).
In Australia, New Zealand and the United Kingdom, this is usually 1% - 2%. In other Asian jurisdictions, this is usually 1.2% - 2.5% of the insured amount.
Which other factors may influence the cost of policy premiums?
Any factor that poses a heightened level of risk is likely to increase the cost of the insurance premium. Some factors which may affect the level of premium that is payable include:
|Limitations of coverage||What is the policy limit?
|Assignability of policy||Can a W&I policy be assigned? Yes, the policy is generally assignable within the insured's group of companies in any post-acquisition restructuring without needing to obtain the prior consent of the insurer. It is also possible to have "additional insureds" (i.e., the target company) so that there is no need to assign the policy after it has been entered into. A seller-side policy however cannot be assigned to a buyer.|
With more widespread use of W&I insurance, the process of obtaining this insurance may become more streamlined, the costs may reduce and new hybrid products are likely to be introduced to the market - making this product a more attractive risk mitigation tool in real estate transactions.