Many deal teams are familiar with the core purpose of warranty and indemnity (W&I) insurance – being to provide an avenue of recourse in the event of a breach of warranty under a purchase agreement. However, as evidenced by the increase in usage of transactional risk insurance in corporate acquisitions over recent years, and because of the resulting development in its sophistication and coverage capabilities, transactional risk insurance and W&I insurance in particular can also be used to help the insured entity achieve its commercial goals. In this article we consider various ways in which transactional risk insurance can be used as part of a deal participant’s corporate strategy.
On the sell-side
Whilst 98% of the policies placed by WTW in 2023 were buy-side policies, our statistics show that more than 30% of all W&I insurance processes were commenced by the seller; and this is most frequently the case when the disposal is taking place by way of an auction process. One of the main reasons for this is that by initiating the process the seller is afforded a degree of visibility over potential gaps in insurance cover. Such gaps often result in pressure being applied by a buyer that is seeking to limit their exposure in these uninsured areas by pushing for increased seller liability in the purchase agreement or a ‘price chip’. Seller initiation of the process therefore provides an early warning mechanism, allowing the prudent seller to pre-empt potential buy-side manoeuvring. Other reasons for seller initiation may include:
On the buy-side
By definition the auction process will be competitive and therefore a bidder could consider how to best use W&I insurance to distinguish their bid. By transferring liability from the purchase agreement onto a W&I insurer, a bidder is able to afford a seller a more attractive net liability position.
Occasionally in a negotiation a commercial point will lead to an impasse between buyer and seller where neither party is willing to concede and alternative structuring solutions are insufficient. Such situations risk the transaction as in the absence of a warranty being agreed, a buyer will have no contractual comfort to allay their concerns. Fortunately, W&I insurance can be utilized in such circumstances to bridge this gap and for an additional premium insurers are often able to consider ‘synthetically’ including warranties in the policy which are not in the purchase agreement.
WTW will also identify areas where, for an additional premium, the scope of the insured’s expose under the warranties can be narrowed by enhancing the W&I policy to ‘scrape’ certain purchase agreement qualifications or conditions (such as materiality qualifying language, knowledge qualifying language and disclosure of the data room to name a few). These policy provisions are sometimes termed 'US style' enhancements by virtue of being market standard on a US style representations and warranties insurance policy.
To the extent that a claim is not covered under a W&I insurance policy, the fall back position is recovery under the purchase agreement. The limitation of liability schedule under a purchase agreement will include a cap on the financial liability of the sellers/warrantors and a limit on the time periods in which claims can be made against them. If these thresholds have been set at a low amount or for a short period (which is often sought by a seller seeking a clean exit), the buyer would be left exposed. This can cause tensions between the parties to the transaction however, W&I insurance can be used to synthetically increase and/or extend the limitations imposed under the purchase agreement, thereby providing the buyer with a greater degree of comfort and avoiding contentious negotiations with their counterpart.
As a buyer will want to be confident that the warranties they relied upon on entering into a transaction are accurate, a clean exit upon closing is unusual. Traditional contractual solutions to this (beyond limits of liability under the transaction documents) include escrows and handover periods and whilst these are useful mechanisms, they are not without their shortfalls. For example, sellers loath to reserve a portion of proceeds for post-closing claims and often want immediate access to the entirety of the proceeds of sale.
Similarly, where a seller is to remain involved with the target entity post-transaction, if the buyer were to pursue that seller for a breach of warranty, this may negatively impact the relationship between the parties, inhibiting a successful handover. By procuring W&I insurance, both the buyer’s and the seller’s ambitions are satisfied; as for the buyer, the contractual protections of the W&I policy substitute the requirement for retained monies and so the sellers are allowed the freedom to utilize the received sale proceeds. Similarly, what might be a pivotal commercial relationship is protected as the buyer benefits from an avenue of recourse other than against the sellers.
Professional advisers might uncover tax risk exposures and contingent risk exposures as part of their diligence. Whilst any such identified risks might be capable of being dealt with by way of a price chip, an indemnity or perhaps a carve out of the 'at risk' aspect(s) of the deal, this creates an additional hurdle which could impact the success of the transaction if the buyer seeks to have liability for the identified risk remain with the seller. Tax insurance and/or contingent risk insurance solutions can often be implemented as an alternative, either by way of affirmative cover under a W&I policy or under a separated tax and/or contingent risk policy, thereby transferring such risks onto the balance sheet of the insurer.
WTW’s Transactional Risks team is made up of qualified lawyers and tax and accountancy practitioners who appreciate the transactional complexities and commercial realities clients face. As such, we are well positioned to guide clients through the process of insuring transactions and ensuring that the policy procured meets all the needs of the insured and addresses the nuances of the transaction; as every transaction is unique, every transaction requires a bespoke solution. We take time to properly understand each client and their position so that we can obtain the insurance fit for them. Clients have plenty to consider when undertaking transactions and therefore the WTW team seek to make the insurance process as straight forward as possible, utilising our wealth of industry experience and leveraging trusted industry relations to negotiate purpose-built policies on your behalf.
