Warranty & Indemnity Insurance for Mergers & Acquisition
Warranty & Indemnity (W&I) insurance is an insurance product that has been developed specifically for the mergers and acquisitions (M&A) market. This type of product is sometimes referred to as Representations and Warranty (R&W) product cover, particularly in the US. W&I insurance provides cover for unidentified breaches of warranties or representations in a share or asset sale agreement, including sale of land contracts.
The purpose of W&I insurance is to transfer the risk of any financial loss that may arise from a breach that arises from a share or asset sale agreement from the seller (or some other person or entity providing the warranty or representation) to the insurer or issuer of the W&I policy.
Types of W&I policies
The majority of W&I insurance policies are what are known as ‘buy-side’ policies. This means that the buyer of the policy can make a claim on the insurance if there is found to be a breach by the seller of any insured warranty or indemnity.
The alternative to a ‘buy-side’ policy is a ‘sell-side’ policy. A ‘sell-side’ policy provides indemnity as between the seller and the insurer which gives the seller coverage in circumstances where the purchaser makes a claim against the seller for an alleged breach of an insured warranty or indemnity. These types of policies are taken out by the seller and can be purchased even without the buyer being made aware of the policy.
How much do W&I policies cost and who pays for the policy?
There is no set fee for a W&I policy in Australia and the final fee will depend on both the particular insurer, the scale of any M&A transaction and the negotiations that have preceded the taking out of the policy. The premium cost of a W&I policy can be paid for by either a buyer or seller and this cost is sometimes factored into price negotiations. As a general rule the fee for a policy will be in the order of 1% – 1.3% of the total of the insured risk.
Why should I consider purchasing a W&I policy?
There are a number of potential benefits to having a W&I policy in place for M&A transactions not the least of which is that it can be a valuable tool in solving potential roadblocks in negotiations on the question of allocation of risk.
Other relevant matters to take into consideration and factors in favour of taking out a W&I policy include the following:
Clean exit – These policies can be used to ensure that a clean exit occurs with defined certainty as to the extent of any potential liability exposure arising out of the transaction. This is particularly true for a seller who can conduct the sale in the knowledge that there will be no lengthy tail liability for potential breaches;
Buyer confidence/transfer of risk – A buyer is likely to take comfort from the fact that if there has been an unidentified breach of warranty or indemnity the W&I policy will effectively place them back in the same position as if the breach had not occurred. This may also mean that there does not need to be any discounting of the purchase price or lengthy escrow provisions built into the transaction. The use of a W&I policy can also assist in facilitating a resolution between the different expectations regarding risk and liability that parties may bring to a transaction;
Protection of Assets & Avoiding Litigation – The use of a W&I policy can mean that in the event of an alleged breach of warranty or indemnity the seller’s assets and the proceeds of sale are protected from potentially expensive litigation;
Distressed Asset Sales/Insolvency – W&I insurance is useful in transactions involving a distressed sale situation because a buyer can take comfort from the additional security offered by the insurance;
Confidence for lenders – The existence of a W&I policy is likely to provide any prospective lender with a degree of certainty and confidence as well;
Multiple sellers/Unwillingness to sue the seller – A buyer may either not wish to have the potential expense and stress of suing for breach of indemnity and warranty where there are multiple sellers involved or may, for some other reason, be reluctant to sue the seller in the event that a breach of warranty or indemnity has occurred. With a W&I policy in place both of these potential problems are averted with any claim being made on the insurer on the policy rather than any seller or group of sellers;
Preservation of relationships – In situations where the seller remains involved in the business or organisation in some capacity after the transaction there is likely to be some reluctance on the part of the seller to sue for a breach. This scenario is also likely to apply in joint venture agreements. A W&I policy shifts the liability for any breach to the insurer and effectively allows the parties to maintain their relationship;
Jurisdictional differences – A buyer entering into a new market may have some concerns and be uncertain as to how it would be able to recover for any breach of warranty or indemnity and may also be concerned about the cost of any such recovery action. Similarly, a seller who is conducting business may be leaving the jurisdiction after the sale and may also want to have certainty as to their exposure for any claims after the sale. W&I insurance takes away this uncertainty as the claim is made on the insurer under the policy rather than via contested litigation; and
Potential to enhance a bid – W&I policies may be used as a means to reduce a seller’s liability and indemnity for any breaches as the policy is able to provide the purchaser with a separate means of reparation for any breaches (above and beyond what the purchaser may be able to claim from the seller).
What is not covered by a W&I policy?
Most W&I ‘sell-side’ policies will seek to exclude any loss suffered as a result of fraudulent conduct by the seller.
While a buyer may be covered against the loss that would arise from fraudulent seller activity if they take out a ‘buy-side’ policy, it is likely that such a policy will give the insurer the seller’s subrogated rights which would then enable the insurer to proceed against the seller directly.
In land related transactions the Insurer may seek to exclude warranties relating to environmental matters and the structure of the building.
The wording of the policy is important and ordinarily requires negotiation with the insurer.