Use of Warranty & Indemnity Insurance in Private M&A Transactions
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Use of Warranty & Indemnity Insurance in Private M&A Transactions Warranties and indemnities play an important role in merger and acquisition (‘M&A’) transactions, enabling the parties to negotiate the balance of risk between them. Warranty and Indemnity insurance (‘W&I Insurance’) allows the parties to shift risk by insuring against potential breach of warranty or indemnity claims by a buyer following completion.
Simon Baker
Michael Barrington
Partner simon.baker@laytons.com +44 (0)1483 407 007
Solicitor michael.barrington@laytons.com +44 (0)1483 407 086
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Use of Warranty & Indemnity Insurance in Private M&A Transactions
Ordinarily, in a private company acquisition, all or some of the sellers or management team (‘Warrantors’) give warranties in relation to the business being sold (‘Target’). Warranties are essentially promises, the nature of which can differ depending on the sector, the parties, and the type of transaction. Generally the Warrantors will seek to disclose certain facts against at least some of the warranties in order to dilute the strength of the promises given. If a warranty is false, or has not been properly disclosed against, a buyer may have a claim against the Warrantors for breach of warranty, and can sue.
Why is W&I Insurance Used? Parties to an M&A transaction ordinarily seek the protection of W&I insurance cover to mitigate risk under the SPA. For a buyer, it can be attractive if it has doubts about the strength of the Warrantors’ promises, or if the buyer intends to have an ongoing relationship with the Warrantors following completion. As the Warrantors often pay at least a share of the premium of any such policy, the buyer has the comfort of the insurance for no or little additional cost. This is often useful for a buyer if the threshold for Warrantors’ liability under the SPA is linked to the total threshold for cover under the insurance policy, as the buyer has the comfort of knowing that successful claims can be made up to the Warrantors’ total liability. For the Warrantors, there are benefits where a buyer is seeking extensive, onerous or forward-looking warranties. By obtaining W&I insurance, Warrantors can effectively limit their
Certain matters may also be the subject of a specific
liability to the extent to which they are comfortable, whilst the
indemnity given by the Warrantors. Indemnities are generally
buyer can insist on the Warrantors giving stringent warranties.
more powerful than warranties, enabling the buyer to claim
Additionally, Warrantors can use W&I insurance to discourage
against the Warrantors (in principle without the need for
‘price-chipping’ by buyers, who might otherwise seek to
litigation), on a ‘pound for pound’ basis for breach, without
reduce the total purchase price if certain warranties were not
having to suffer some foreseeable loss in order to adequately
given.
substantiate a claim (or generally to mitigate the damage suffered).
W&I insurance can also benefit specific Warrantors in different ways. For example, a private equity Warrantor (i.e. who is not
W&I Insurance can be taken out by the buyer or Warrantors
involved in the business day-to-day), who may not want to
to cover losses suffered by a buyer in relation to a claim for
give extensive warranties, could achieve a clean break from
breach of warranty or against an indemnity. If the buyer takes
the Target company and ensure funds are more easily and
out the policy, it can make a claim under the insurance policy
readily returned to investors. W&I insurance allows them
for an agreed warranty claim for losses above the claims
to shift the risk of future claims to a third party, whilst also
cap in the sale and purchase agreement (‘SPA’). If the policy
avoiding placing often large proportions of the purchase price
is taken out by the Warrantors, the buyer can claim directly
in an escrow account pending expiry of the claims limitation
against the Warrantors, who then seek to recover that loss
period in the SPA.
from the insurer.
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Use of Warranty & Indemnity Insurance in Private M&A Transactions
W&I insurance can also be preferable if there are numerous sellers with varying degrees of involvement in the Target,
Conclusion
not all of whom will be Warrantors. It is not uncommon for a
W&I insurance can be a vital tool in private M&A transactions
Target that has undergone multiple stages of fundraising to
to ensure that parties are comfortable with the amount of risk
have many small investors who have little or no involvement
they are assuming. Although obtaining W&I insurance does
in its day-to-day operations, and who therefore will be
not absolve a Warrantor of adequately disclosing against
unwilling to give warranties. W&I insurance enables the buyer
warranties, or excuse buyers from undertaking an extensive
to gain the benefit of warranty and indemnity protection
due diligence exercise, it is helpful in ensuring that both
without those Warrantors having any ongoing personal
parties are able to apportion risk appropriately.
liability. This also enables sale proceeds to be released to those investors more quickly than if funds were retained in escrow following completion.
Issues with W&I Insurance Typically, insurers will ensure that certain risks are not covered by a W&I insurance policy, and therefore Warrantors may retain some liability for certain matters. For example, issues identified in due diligence, forward-looking warranties, and certain categories of warranties (such as those relating to bribery, environmental liability, or regulatory compliance) can often be specifically excluded from the scope of the policy. Policies also typically contain a minimum amount for claims (the ‘policy attachment point’), up to which Warrantors (or, occasionally, the buyer) will be liable, and insurers may also require some warranties to be capped by Warrantor knowledge. For parties seeking to complete a transaction in a short time, W&I Insurance may not be appropriate. Not only will insurers need to review the SPA and related ancillary documents – notably the disclosure letter – which can cause some delay, they will likely also require full due diligence and disclosure exercises to have taken place.
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Use of Warranty & Indemnity Insurance in Private M&A Transactions
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Michael Barrington
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This information is offered on the basis that it is a general guide only and not a substitute for legal advice. We cannot accept any responsibility for any liabilities of any kind incurred in reliance on this information.
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