A warranty and indemnity (W&I) insurance policy will cover the warranties and the tax indemnity given by the sellers to the buyer under an acquisition agreement. Policy exclusions scale back coverage, bringing it in line with the scope of coverage that W&I insurance is designed to provide and such that any known deal specific matters that arise during due diligence or any matters that are otherwise outside of insurer appetite are placed outside of cover. This article considers W&I policy exclusions and their employment in the current market and touches on how to approach exclusion limitation. W&I policy exclusions fall into three categories: (i) general exclusions, (ii) deal specific exclusions and (iii) warranty amendments.
General exclusions are those which apply across the W&I insurance market and tend to address matters that cannot be covered because they fall within the knowledge of the deal team including by virtue of being disclosed in the data room, in due diligence reports or in customary public searches. Issues such as purchase price adjustments (or leakage for locked box accounts deals), fraud of the insured, secondary tax liabilities, transfer pricing, deferred tax assets, war, terrorism, sanctions and fines which are uninsurable by law will fall within this category.
As the name suggests, deal specific exclusions address those matters which arise from the specific features of the insured transaction. The starting point for W&I insurance is that cover is only available for areas which have been subject to due diligence. As such, deal specific exclusions often arise where there is insufficient due diligence. Other deal specific exclusions may relate to jurisdictional spread (high risk jurisdictions will often be excluded from cover in whole or in part (e.g. ABC matters)), specific indemnities, condition of assets and real estate defects, pension underfunding, pollution and contamination, all of which are commonly excluded on a transaction which has such exposures.
If a W&I Insurer is not comfortable with providing cover for a certain warranty as constituted in the transaction document, they will at times deem it amended, with the insurer’s preferred amended warranty form usually being set out in the W&I policy or warranty spreadsheet. Typical warranty amendments required by W&I insurers range from removal of any forward-looking statements, estimates or forecasts, to seller knowledge qualifiers being inserted for matters which only third parties would properly have knowledge of. Where an insurer takes the view that a warranty cannot be covered even with amendment, the insurer will, as a last resort, seek to exclude it altogether. The process of ensuring that individual warranties can be covered based on an analysis of due diligence and considering an insurer’s appetite is an important aspect of a W&I policy negotiations and often constitutes its most contentious aspect. One key point to consider when negotiating the amendment of warranties is the effect that the drafting of headline exclusions may have on coverage throughout the policy and the potential conflict between purported cover as set out in a policy warranty spreadsheet and a headline exclusion. As is evident from the failure of the insured to claim a mistake in the drafting of an ABC exclusion in Project Angel Bidco Ltd v Axis Managing Agency Ltd a focus on the drafting of such exclusions is critical because of its impact on the scope of covered warranties.
The ebb and flow of M&A transaction volume and the wider macro-economic landscape will always have an impact on how a W&I insurer approaches exclusions. Likewise, new market entrants and the increase in underwriting capacity that they bring adds risk appetite pressures for W&I insurers seeking to differentiate themselves from their peers. With this in mind, the most noteworthy market development from the perspective of exclusions may be the increasing flexibility and willingness of insurers to provide solutions for areas of risk outside of those traditionally considered to be W&I risk. By, for example, providing affirmative cover by way of enhancement (or by insurers providing bespoke policies to address these areas of exposure). As regards bespoke policies to address other exposures, there is a longstanding appetite for standalone tax insurance (the topic of the next article in this series) and contingent risk insurance, insurers however are increasingly considering intellectual property and other known risk cover within their W&I policies (sometimes now included without knowledge qualification) and in some cases with cover for forward looking warranties.
The fluid nature of ‘market standard’ exclusions is also worthy of note as exclusions related to covid and conflict (whether Ukraine or the Middle East) have come and gone as insurers increase their familiarity with perceived risks emanating from these issues and become more willing to bring them within the scope of cover.
The key to limiting potential exclusions is early engagement with the W&I process. While a deal may bring unique challenges from a W&I coverage perspective, these may be overcome more readily where the prospective insured has ample time to consult with their broker and where the deal team has allowed sufficient time for due diligence to be re-visited. Early engagement allows for the identification of areas of underwriting focus and the pre-emption of obstructions with the possibility of a considered solution. In the context of an M&A transaction where there is a tight timeframe this approach may not always be practical and in such circumstances a W&I broker earns their keep by compiling a placement strategy that mines the market for those underwriters most willing to engage with the issues.
