In an M&A deal, transactional risk allocation is always a major concern for both sellers and buyers. While sellers seek a clean exit for the post-deal period, buyers want to ensure they can turn to a reliable party with good financial standing should damages arise from breach of warranties. That is when warranty and indemnity insurance ("W&I insurance") comes to the rescue. Despite its benefits, in the absence of specific legislation or established practice in Turkey, this new product is still waiting to gain popularity to a wider range of Turkish insurance companies and M&A market players.
What is W&I Insurance?
W&I Insurance is an insurance policy (taken out by either the seller or the buyer) that covers damages incurred by the buyer due to the seller's breach of representations and warranties under the share purchase agreement ("SPA"). Its main advantage is maintaining equilibrium between the parties' interests by shifting the transactional risk to an insurer in return for a one-off insurance premium.
Sell-side insurance is a third party insurance policy where the seller knocks on the insurer's door when the buyer resorts to the seller for indemnification. It balances what the seller is prepared to cover and what the buyer would require and the difference is promised by the insurer. It is advantageous for the seller when the parties, as continuing business partners, wish to avoid conflicts regarding indemnification during the post-closing period.
Buy-side insurance is a first party insurance policy where the buyer directly recovers the claim from the insurer once damages are incurred. This saves the buyer from dispute process and offers comfort to buyers knowing that adequate coverage will be secured.
As a feature appealing to both parties, W&I Insurance also eliminates or reduces the need for complex escrow, holdback, or adjustment mechanisms.
In the Turkish market, the number of closed deals involving W&I insurance is still significantly low. It is a tool that is relatively more appealing to individual sellers and financial investors that have not been fully involved in the day-to-day operations of the target and are not willing to be held accountable vis--vis the buyer going forward.
What is the scope of the insurance coverage?
The scope of coverage is negotiated and customized for each deal. While parties would ideally want the insurance coverage to be back-to-back with the SPA’s indemnification regime, in certain areas insurers may diverge from the SPA and exclude certain aspects from the policy, such as risks already known by the buyer, fraud, bribery and corruption, forward-looking statements on performance of the target, and political risk. Transaction-specific exclusions are also very common when the warranties are broadly drafted or no sufficient due diligence exercise was conducted.
The policy period for Turkish W&I insurance is pretty much in line with globally accepted standards where coverage for fundamental warranties and tax warranties are valid for around 5 to 7 years and general warranties are valid from 1.5 to 3 years. De minimis thresholds, the amount a single claim must exceed for the buyer to be qualified as indemnified, are typically set at 0.1% of the deal value.
What is the procedure for W&I Insurance policy drafting?
As each deal is unique, it is crucial that insurers run their own due diligence on the disclosure process (the "underwriting review"), particularly regarding a general review of the data room, written logs of Q&A sessions, legal due diligence reports, transaction documents (especially the close-to-final draft of the SPA), and disclosure letters.
This review process will be followed by an underwriting call led by the insurer's legal counsel with all of the deal parties and advisors' participation to seek responses from the buyer on their comfort level regarding specific areas of concern over the target's business and risks in order to identify the possibility of facing any further risks in these areas.
If no major red flags are found, the premium can be reduced or if the legal counsel determines that sufficient emphasis was not put on certain red flag issues in the due diligence documents, these matters will likely be taken out of the coverage.
Insurer's legal counsel expects to confirm that the buyer did not solely rely on insurance and conducted a thorough review of the target, ran fair negotiations with the seller, and produced a well-drafted set of warranties. In certain cases, the insurer's legal counsel may even exclude excessively extensive warranties from the coverage or re-draft them to be more specific.
Who pays the insurance premium?
Who pays the premium depends on whether the policy is a sell-side or buy-side policy. The majority of W&I insurance policies in the Turkish market seem to be buy-side policies, and therefore, the premium is paid by the buyer. Sometimes costs are equally split between the parties. The premium is a one-off amount and usually corresponds to less than 2% of the insurance coverage limit. SPAs usually have specific provisions naming the obligations of the parties regarding premium payments.
Lack of a Specific Legal Framework
W&I Insurance is still relatively new to the Turkish M&A market and the number of projects involving them is still quite low. Recent policies are mostly taken out by non-Turkish deal parties through nonTurkish insurance companies. One major reason why is the lack of a specific legal framework surrounding W&I Insurance. Since W&I Insurance is not among the insurance categories specified under Turkish legislation, the only option for Turkish insurance companies for now is to obtain the approval of the Directorate General of Insurance to issue W&I Insurance policies within the scope of one of the general categories specified in their operation licenses (such as surety, general liability, or financial losses). Very few Turkish insurance companies have officially started to get the relevant authority’s approval for the product. It will hopefully become a widely-used and well-known tool as many more precedents develop in the market accompanied by specific legislation.