Warranty & Indemnity Insurance – 5 Things To Consider

This month we focus on five things to consider regarding warranty and indemnity ("W&I") insurance for an M&A transaction. W&I insurance provides the insured seller or buyer with cover for losses suffered from warranty breaches and claims under the general tax indemnity under a sale and purchase agreement ("SPA").

1. Why W&I insurance?

   A key advantage of W&I insurance for a seller is that it limits its liability and offers a "clean exit" from an investment. This is particularly important for private equity sellers who may be unable to take on liability under their fund terms and/or need to make immediate distributions of sale proceeds to their limited partners. W&I insurance also has many advantages for a buyer. For example, a buyer may prefer to claim against a W&I insurance policy rather than the sellers/warrantors who remain with the management team of the acquired business, or the buyer may have concerns regarding the covenant strength of a seller/warrantor. W&I insurance policies are almost always taken out in a buyer's name (so it has direct recourse to the insurer). If a seller introduces W&I insurance into an M&A transaction, it will most likely "flip" the policy to the buyer just before completion of the transaction.

2. Think about W&I insurance early (and tactically)

   Sellers and buyers alike should consider W&I insurance early in the M&A process, particularly in an auction context. A seller running an auction process may wish to "staple" a W&I insurance policy to the auction draft SPA it provides to bidders. Recently, some sellers have gone further by offering a suite of warranties that have been pre-agreed with an insurer and are broader than the standard set of auction warranties. This may potentially enhance the value and comparability of the bids a seller receives as it enables buyers to more easily "price in" transaction risk at an earlier stage.

   Conversely, where a seller does not take this approach, a proactive buyer may consider agreeing coverage for a suite of warranties (and potentially a tax indemnity) in advance with a W&I insurance provider and submit that W&I insurance policy to the seller together with its draft SPA mark-up. This may help improve a buyer's bid as the negotiation of warranties then largely becomes a matter between the buyer and the insurer (not the seller), reducing the seller's time and cost during the auction process.

3. How much does it cost and who pays?

   W&I insurance premiums for UK M&A transactions...