What is Warranty & Indemnity Insurance?
Warranty and Indemnity (W&I) insurance is now a well-established and commonly used transaction (M&A) risk mitigation tool that has come to be expected by deal parties on transactions i.e., during the potential acquisition or sale of a target business whether by way of a share or asset sale.
Typically used on deals where the buyer will be conducting requisite due diligence on the target business, W&I insurance can be used for any transaction structure including but not limited to typical private M&A transactions, real estate transactions, equal mergers, public M&A transaction (friendly take-overs and take-privates), distressed sales, capital raises, cross-border deals, etc.
Who should consider W&I insurance cover and when?
We recommend M&A advisors and deal parties engage with Bellrock and begin socialising the messaging on W&I amongst key internal stakeholders, which include the deal team, CFO, legal counsel, and/or key M&A advisors prior to/while preparing the Information Memorandum (IM)/management presentation on the transaction.
What does W&I insurance cover?
At its simplest level, W&I insurance transfers the historic unknown operational risks relating to the target business to the insurance market, de-risking the transaction. Having initially gained popularity amongst private equity/financial sponsor clients seeking a clean exit from investments, W&I insurance is now strongly endorsed by strategic sponsors for its numerous benefits.
Subject to the underwriters’ review, a W&I policy provides cover for a breach of title and capacity, tax and general warranties given under a share sale and purchase agreement (Sale Agreement). It is typical for a seller of the target business to provide the buyer with a set of negotiated warranties under the relevant Sale Agreement or similar transaction document. These warranties relate to the title and capacity of the seller, ownership of the shares/units/assets, and operational business risks. There are historic unknown risks underpinning these warranties and W&I insurance covers an insured loss with respect to a breach of these warranties when these unknown risks materialise.
Under a buyer’s W&I insurance policy, coverage will be determined by underwriters and informed by their review of the buyer’s due diligence, information disclosed by the seller in the virtual data room (VDR) and underwriting Q&A.
Common exclusions
The policy will be subject to certain standard and deal specific exclusions including:
- Specific indemnities, known issues and breaches of covenants
- Matters which are fairly disclosed
- Uninsurable fines and penalties
- Consequential loss
- Forward looking statements, forecasts and projections
- Purchase price adjustments.
Types of W&I insurance policies
Buyer’s (buy-side) W&I insurance
A buy-side W&I policy is the most commonly placed W&I insurance policy and covers a buyer for loss arising from a breach of the seller warranties (including seller fraud) and the relevant indemnities under the Sale Agreement. The buyer, as the insured party, can make a claim directly against the W&I insurer subject to the terms and conditions of the W&I insurance policy. The buyer will also be covered for W&I insured third party claims that are made against the target business.
Seller’s (sell-side) W&I insurance
A sell-side W&I policy covers the seller for loss arising from a claim made by the buyer against the seller under the Sale Agreement for a breach of warranty. This type of W&I insurance policy is less common when compared to a buyer’s W&I insurance policy, and the policy parameters and response will align with the seller’s liability structure under the Sale Agreement. It is a useful option for sellers in circumstances where there is recourse to the seller under the Sale Agreement for a breach of seller warranties and they look to protect themselves against loss arising from a buyer’s claims in respect of warranty breaches. This typically arises where the buyer is unwilling to take out a W&I insurance policy and has the leverage to hold this position.
Benefits of W&I insurance
There are benefits to both the buyer and seller in structuring a W&I insurance programme to de-risk the transaction. From a buyer’s perspective, these include direct recourse to a policy of insurance, access to a clean claims process, liquidity in the event of a claim, preserving relationships with existing seller shareholders, and potentially enhancing its position under the W&I insurance policy when compared to the Sale Agreement. The Sellers benefit from a clean exit and/or a limited recourse structure that might otherwise be unavailable in the absence of W&I insurance. With regards to the transaction, for a one off premium (typically lower than the current interest rate), it may help replace the escrow or purchase price hold-back amount.
How to secure a W&I insurance policy
This is usually a two stage process which will involve Bellrock marketing the transaction and the selected insurer/s underwriting the transaction, before ultimately incepting the W&I insurance policy for the transaction. Once Bellrock is formally engaged by the buyer/policyholder, we will work with them and the insurer through the underwriting process, to negotiate competitive terms and place the W&I insurance policy on behalf of the buyer/policyholder.
Sell-buy flip
The colloquial ‘sell-buy-flip’ has become commonplace for W&I on sale processes, particularly where the seller is in discussions with multiple bidders or running a competitive auction process. A W&I insurance policy can support an enhanced bid and offer purchase price protection for the buyer.
Sell-buy-flip involves a seller-initiated W&I process (sell-side process), engaging with Bellrock to market and structure the proposed W&I insurance programme on the sell-side for the benefit of bidders that will ultimately take out a buy-side W&I insurance policy. Where there is vendor due diligence being, a degree of underwriting on the sell-side may also be undertaken. The selected insurer is also appointed to progress the W&I workstream prior to switching engagement to the selected buyer/bidders at an appropriate time in the transaction process. Sellers have greater visibility and control over marketing, insurer selection and structuring of the W&I insurance programme, which is packaged and presented to the buyer/bidders.
Early engagement on the sell-side is critical to running an efficient and effective W&I process. This early involvement also informs the scope of seller disclosures required to facilitate the buy-side diligence expected by W&I insurers. We collaborate with the sellers and their corporate advisors prior to issuing the IM to agree on strategy and approach.
Other key W&I insurance policy considerations
- Insured limit up to 100% of the target enterprise value (from a few million to billions).
- One-time premium payable upon completion of the transaction.
- Payment of premium is ultimately a commercial decision to be made between the buyer and seller and is often treated as a transaction cost built into the funds flow at completion. The party that has greater leverage often passes the cost on to the other party.
- Policy period from the commencement date until up to (i) 7 years from the completion date for 7 years for a breach of title & capacity warranties (or a corresponding indemnity claim), tax warranties and a claim under the tax indemnity, and up to (ii) 3 years from the completion date for a breach of general/business warranties (or a corresponding indemnity claim). Note that the policy period therefore does not necessarily mirror the time limits imposed under the Sale Agreement, as they operate independently.
Please reach out to the Transaction (M&A) and Contingent Risk team to discuss your queries on de-risking transactions.
