Buy-Side Warranty And Indemnity Insurance – Increased Coverage Gaps

As warranty and indemnity insurance continues to offer bespoke policies in an ever competitive market, we consider the key considerations for buyers at the outset of a transaction and the common gaps in coverage.

Background

The popularity of warranty and indemnity insurance has continued to expand in M&A transactions across Europe, the United States and, most recently, Asia. In summary, warranty and indemnity insurance offers coverage for losses arising from warranty and indemnity claims under a sale and purchase agreement / tax deed of indemnity and can be in the form of either a buy- or sell-side policy:

Sell-Side - The seller is the insured party and the buyer will claim directly against the seller for any losses. The seller will recover insured losses from the insurer, who may control any defence or settlement of such claim. Buy-Side - The buyer is the insured party and the buyer will claim directly against the insurer for insured losses above the capped liability of the seller (which can be a nominal £1 cap). The Growth of Buy-Side Policies

Buy-side insurance policies have become increasingly popular, most commonly in relation to private equity transactions, indirect real estate disposals and distressed sales. The benefits of warranty and indemnity insurance for sellers include offering a clean break, the opportunity to distribute sale proceeds immediately following completion and removing or reducing the requirement for retention of sale proceeds in escrow. In auction processes, a buyer may consider offering to obtain a buy-side policy in order to make its bid more attractive in a competitive marketplace. While buyers also benefit from security of settlement of an insured claim, by mitigating the risk presented by a seller with insufficient funds to settle claims or a seller who is likely to be wound up shortly following completion, buy-side insurance policies can leave material gaps in coverage which may offset the value of the policy.

Level of Coverage

While insurers may be willing to cover 100 per cent of the equity value, this level of coverage and the accompanying premium will cause the buyer to decide the percentage of equity value that is sufficient to cover foreseeable losses in the business. While lower coverage is common in real estate SPV transactions, a higher level of coverage (e.g. 20 per cent of the equity value) is more likely for trading businesses such as tech or pharmaceuticals businesses. On some of the highest...