Driven by private equity sellers seeking a clean break and no post-closing liability for a breach of business warranties or under a tax covenant, and by buyers requiring a source of meaningful financial recourse, warranty and indemnity (W&I) insurance is now a common feature of most private M&A transactions governed by English law.

What is W&I insurance?

W&I insurance provides cover for losses discovered by a buyer post-closing arising from a breach of warranty or, in certain cases, under an indemnity such as a tax covenant. W&I insurance aims to offer back-to-back cover for any liability arising from a breach of warranty or for liability under an indemnity, in each case where the matter giving rise to such a claim has not been fairly disclosed or was unknown to the insured party.

In addition to providing cover for customary warranties and indemnities, insurance coverage can also be put in place for specific tax liabilities and non-tax liabilities or one-off risks.

What amount can be insured?

Subject to sufficient capacity in the insurance market, cover is available for up to the full amount of consideration under a share purchase agreement if required (up to a London market capacity level estimated to be approximately £1.1 billion). However, typically, buy-side policies – those taken out by a buyer with an insurer – provide cover in the range of 10% to 50% of the enterprise value of the target.

What premium and excess/policy retention is standard?

Net insurance premiums on transactions covered through the London insurance market are typically between 1% and 2% of the insured limit. The premium is payable in full for the entire period of the policy from when it is taken out or shortly thereafter.

In addition to the premium, UK-domiciled insureds must pay insurance premium tax at 12% of the total premium. Other additional costs include the underwriters' due diligence or external legal fees and any brokers' fees.

In general, insurers will require that the insured party bears an excess of at least 1% and possibly up to 2% of the enterprise value of the target at their own risk before the insurance policy attaches. Typically, the policy excess operates after erosion of the minimum claims limitations (the de minimis and basket) negotiated under the share purchase agreement.

Notwithstanding this, insurers are increasingly offering cover with a £1 attachment point and are happy to consider writing out of a W&I policy those limitations that might ordinarily be found in a share purchase agreement.

How long will the policy last? A policy generally reflects the duration of the warranties or the indemnity, as the case may be, given in the share purchase agreement.

However, irrespective of the period of potential liability under the warranties or indemnity in the share purchase agreement, a buy-side policy can usually be written to provide insurance for two years post-closing for business warranties and seven years post-closing for tax warranties or a tax covenant.

A longer policy duration will generally result in a higher insurance premium.

What are typical policy exclusions?

Typically, policy exclusions include:

  • fraud and matters which the insured party was aware of on inception;
  • changes to transaction documents without underwriter consent;
  • fines and penalties;
  • bribery and corruption;
  • cyber/IT-related liabilities;
  • transfer pricing, secondary tax liabilities and loss of deferred tax assets;
  • underfunding of pension schemes;
  • purchase price adjustments; and
  • forward-looking warranties.

How is a policy obtained and cover arranged?

The process for obtaining cover can be broken down into the indicative stages and timescales, with an overall timetable of approximately 10 to 18 business days, as set out below:

  • Broker's conceptual review (one to two business days) – the broker provides confidential, high-level guidance on the structure of the W&I policy required and likely pricing. Limited or no documentation is required at this stage.
  • Submission and non-binding indication of interest by insurers (one to three business days) – a draft of the share purchase agreement and other basic deal information (including accounts and an information memorandum) are made available to the broker. The broker makes a formal submission to potential insurers to obtain a non-binding indication. Insurers enter into confidentiality undertakings before receiving and reviewing information on the transaction and then providing a non-binding indication of terms, including premium costs and excess.
  • Underwriting due diligence (seven to 10 business days) – the buyer selects a preferred insurer to conduct its underwriting due diligence. Certain brokers may require the buyer to pay an underwriting fee (to cover external legal fees) at this stage – a typical fee may range from £25,000 to £50,000. Underwriting diligence typically involves the review of transaction documents and due diligence reports by the underwriter and its advisers and an underwriting due diligence call typically lasting not more than one hour. After this, the underwriter will offer a formal quotation based on its standard policy form.
  • Completion and binding offer of cover (one to three business days) – the insurer's standard policy wording is reviewed and negotiated to align with the final share purchase agreement. As the insured party, the buyer must provide a no-claims declaration to the insurer before the insurer issues confirmation of cover and a final insurance policy based on the final transaction documents. Signed transaction documents are provided to the insurer post-signing and the premium is settled shortly after confirmation of cover.

Notwithstanding this, the insurance process can be completed in a matter of days if a buyer has substantially completed diligence and is familiar with the requirements of the underwriting process and the transaction and related risks to be covered are more straightforward.

For further information on this topic please contact Will Pearce or William Tong at Davis Polk & Wardwell London LLP by telephone (+44 20 7418 1300) or email (will.pearce@davispolk.com or william.tong@davispolk.com). The Davis Polk & Wardwell website can be accessed at www.davispolk.com.

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