What is Warranty and Indemnity Insurance and is it right for my deal?
What is Warranty and Indemnity Insurance (“W&II”)?
In M&A transactions a buyer will require the seller to make certain statements about the business being sold (warranties) or require the seller to promise to pay the buyer for any liability resulting out of a particular circumstance (indemnities). The idea being that, if a warranty statement is breached or the buyer suffers loss for which it is indemnified, the buyer can bring a claim against the seller for its loss.
W&II provides cover for losses arising out of those breaches of warranties and (in certain circumstances) indemnities.
A W&II policy can be taken out on either the seller-side or the buyer-side and the identity of the insured will affect how the policy operates. A seller policy will cover the persons giving the warranties so that if a buyer brings a claim for breach of warranty/indemnity, the warrantors can turn to the W&II policy to cover any resulting liability (subject to certain exclusions and excess provisions). A buyer policy will cover the buyer in the event that they have suffered a loss for something that would be a breach of warranty but the buyer cannot recover that loss from the warrantors (for example, where the warrantors have limited their liability to a certain level, the buyer can increase their warranty coverage through a claim against the W&II policy).
Regardless of which side takes out the W&II policy they are not designed to, so do not provide cover for, certain circumstances.
- the buyer will still be expected by the insurer to carry out a thorough investigation into the target business and the seller will be expected to carry out a thorough disclosure process (where the seller notifies the buyer of any circumstances which would otherwise render a warranty statement untrue prior to completion so as to limit their liability under the warranties and enable the buyer to find out as much about the target business as possible);
- forward-looking warranties (such as warranties about the ability of the buyer to collect the target’s receivables after completion);
- issues which are already known by the insured i.e. known by the seller but not disclosed to the buyer in a seller-side policy, or disclosed to or discovered by the buyer as part of its investigations or the disclosure process in a buyer-side policy. Usually issues known to a buyer will instead be covered by an indemnity and in certain circumstances an insurer will be willing to provide cover for any liability arising out of that indemnity but, given the increased risk, the premiums and excesses tend to be higher;
- price adjustments (such as a reduction in the purchase price due to the target business not having a specific level of working capital at completion); and
- criminal fines and penalties (to the extent the law does not allow for them to be insured).
We have noticed a steady increase in the utilisation of W&II policies in recent years, resulting in more competition in the W&II market, lower premiums and more flexible policy terms. W&II is becoming a more commercially viable option.
Is W&II right for my deal?
If you are a potential seller of a business, W&II may be relevant:
- if you want or need access to the sale proceeds as soon as possible after completion. A W&II policy may enable you to distribute proceeds more quickly after the sale;
- If there are several sellers and the warranties are given on a joint and several basis. The buyer may only seek remedy from one seller due to the inconvenience of trying to claim from a number of sellers, leaving the more accessible seller at risk;
- if you are providing warranties in your own name and want to protect your personal assets by limiting your potential exposure;
- as a tool to reduce your period of risk and/or to avoid placing a portion of the sales proceeds in an escrow account; and/or
- if you are concerned with the buyer’s history of bringing claims in similar transactions or a specific buyer’s litigious nature.
If you are a potential buyer of a business, W&II may be relevant if:
- you are taking part in a competitive bidding process for a business. Showing a willingness to move liability from the owners of the business to an insurance policy may make your bid more attractive to the seller;
- you want a higher level of warranty cover than the seller is prepared to give commercially;
- the private equity or venture capital seller are not giving warranties so warranties are being given by the target’s management team and limited to their own proceeds which is much lower than the overall deal value. The W&II policy can give you additional protection, over and above the cap imposed by the management team;
- the warranties are being given by the management team which is being kept on post-completion and you do not want to bring a claim against your own employees if a breach were to occur (please note that W&II cover that removes the warrantor’s liability altogether would result in higher premiums); and/or
- you are concerned with the seller’s ability to meet any liability for a warranty and/or indemnity claim.
Tughans has cultivated relationships with brokers and we understand what an insurer will need when pricing and putting in place a policy. We can ensure that, where W&II is needed, it can be obtained quickly, efficiently and without impacting on any completion deadlines. We appreciate that premium costs are important but we also understand that the underlying policy must be appropriate. We have the experience necessary to assist you in negotiating the policy terms best suited to your transaction and risk appetite.
If you want to know more about W&II, or are considering the sale or purchase of a business more generally, please contact us. We would be happy to discuss your transaction and circumstances in more detail with you.
While great care has been taken in the preparation of the content of this article, it does not purport to be a comprehensive statement of the relevant law and full professional advice should be taken before any action is taken in reliance on any item covered.