A report published by Thomas Reuters’ Practical Law in 2020 showed that warranty and indemnity (W&I) insurance policy backed M&A deals were up year on year since 2014 and this growth looks set to continue. It’s certainly something we’re seeing here at HCR. But what is W&I insurance and what are its benefits?
Let’s start by acknowledging that a buyer and a seller naturally have opposing interests on the sale and purchase of a business. This is particularly true in the context of the warranties, indemnities and tax covenant. The buyer wants these to be as extensive and unqualified as possible; the seller wants to limit their liability under them and exit without ongoing potential liability.
W&I insurance seeks to bridge this gap between the buyer and the seller by providing cover for losses arising from a breach of warranty, indemnity or tax covenant.
Buy-side W&I insurance policies
W&I insurance was originally a sell-side product, but most W&I insurance policies are now taken out by buyers. With a buy-side policy, the buyer can make a claim against the insurer rather than bring a warranty or indemnity claim against the seller under the sale and purchase agreement. Because of this, a buyer is more likely to allow the seller to cap its liability at a lower amount than would have been acceptable without the policy. This allows a cleaner exit for the seller. Although a buy-side product, it is not necessarily the buyer who pays the premiums. This is a matter of negotiation between the parties.
Sell-side W&I insurance policies
A sell-side policy only applies if the buyer makes a warranty/indemnity claim against the seller under the sale and purchase agreement. If the buyer makes a claim, the seller will be obliged by the terms of the policy to co-operate with the insurer in defending the claim. Sell-side policies are less flexible and generally do not allow larger policy limits. Because of this, sell-side policies are becoming less common.
What is becoming increasingly common is “stapling”. This is where the seller proposes (or insists) that the buyer enters a buy-side policy to underpin the seller’s warranties and indemnities. In other words, it’s a buy-side but seller-initiated policy.
Benefits of W&I insurance
The main benefits of a buy-side W&I policy are:
For the buyer
- The buyer can claim directly against the insurer without having to pursue the seller.
- It gives better contractual protection and a strong counterparty to recover from.
- It mitigates multi-jurisdictional enforcement issues in cross-border transactions.
- It preserves the (often ongoing) relationship between buyer and seller (by offering an alternative to suing the seller).
For the seller
- A seller can usually cap its liability at a lower amount than would otherwise have been possible – enabling a cleaner exit.
- It can help avoid the need for deferred structure and escrow arrangements – permitting a faster distribution of sale proceeds.
- It gives peace of mind.
HCR’s Corporate team have experience advising on W&I backed deals (for buyers and sellers) and are therefore aware of common issues and pitfalls to avoid. Talk to us to discuss your options.