This year we have seen strong private M&A activity and the use of warranty and indemnity (“W&I”) insurance in a number of transactions.
W&I insurance is a specialist insurance product designed to protect against financial loss resulting from claims under the warranties and indemnities given in relation to an acquired business. It is a tool to allocate and manage risk and can be an attractive option that is available to both buyers and sellers. For sellers, it offers a clean exit without a tail of contingent liabilities and the prompt distribution of sale proceeds as retention amounts are less likely to be required to cover warranty and indemnity claims. It also gives buyers the comfort of having access to meaningful financial recourse against the insurer as opposed to pursuing a seller and its assets in the event of a claim.
There are a number of other reasons why W&I insurance cover may be sought:
- To break a deadlock where negotiations reach an impasse in order to facilitate completion of a deal that might otherwise fail;
- For widely held companies or co-operative companies, it may be inappropriate for the shareholder base to be liable for the warranties and indemnities being given by the target company;
- If the seller is retaining an interest in the target company post-sale, W&I insurance helps eliminate any tension around potential warranty and indemnity claims which could otherwise affect the relationship between the parties;
- The nature of the buyer or industry, i.e. if the buyer is a large, aggressive and highly litigious company or the industry is inherently risky, the seller may be more inclined to give certain warranties and indemnities if they know their risk will be underwritten; and
- Stage of exit, i.e. if the owner is retiring and the sale proceeds is their nest egg, they may wish to protect against its potential erosion by warranty and indemnity claims.
While W&I insurance is a viable risk-allocation tool, there will be inevitable gaps between the liability regime under the transaction and the W&I cover due to policy exclusions such as transaction specific carve-outs, matters disclosed in due diligence, criminal penalties and fines, environmental matters and consequential losses. However, with premiums generally ranging from 1% to 3% of transaction value (depending on the extent of cover), obtaining cover may be considered a worthwhile transaction cost.