What is warranty and indemnity insurance?
Philipp Weber
by Philipp Weber
Warranty and Indemnity ("W&I") insurance covers the sellers’ liability in the event of a breach of their representations and warranties (including tax indemnification) under a sale and purchase agreement (“SPA”).
Over the last decade this type of insurance policy has been increasingly used in M&A transactions, and W&I insurance is available as both a seller or a buyer policy. However, in more than 99 percent of transactions, it is obtained by the buyer and the premium is deducted from the purchase price. The premium consists of an underwriting fee (usually EUR 10 to 30,000) plus 1 to 2 percent (0.5 to 1 percent for real estate transactions) of the maximum liability covered by the insurance policy. However, the costs of W&I insurance depend on various factors. Typically, the insurance covers an amount from 10 to 30 percent of the purchase price.
Generally, W&I insurance could be very useful in the following scenarios:
The sellers (e.g. private equity or venture capital funds or business angels) are unable or unwilling to provide any business representations, assume any liability, or require a so-called “clean exit” without any holdback, escrow, etc.
In complex scenarios with numerous sellers (e.g. venture capital backed targets) it could simplify, streamline and shorten the SPA negotiation process regarding the scope and wording of representations and warranties.
Recourse against sellers is difficult if they are pure SPVs or located abroad.
The sellers include the management of the target company, and the buyer wishes to protect the future business relationship following closing. For example, one of the sellers will continue to serve as a director of the target company post-closing.
The buyer requires more favourable limitation periods, caps, etc., which are provided by the W&I insurance by way of so-called enhancements or synthetic structures.
In distressed scenarios where no representations and warranties can be provided by the sellers and/or the insolvency administrator.
The buyer wants to appear more attractive in an auction bidding process.
However, when using W&I insurance in a transaction, it is important to consider the following items:
As early as possible, the process of taking out W&I insurance must be integrated in the transaction process and timeline; typically, the sellers instruct an insurance broker to approach potential W&I insurers in order to receive non-binding indications of interest.
The due diligence process and report must cover all aspects to be insured under the W&I insurance policy.
The terms and conditions of the SPA must be aligned with the W&I policy.
The buyer needs to negotiate the final terms of the W&I insurance policy; i.e. a third party must be closely involved in the transaction process.
Known or disclosed facts or risks will not be insured. (For example, contingencies identified in the due diligence process, or disclosed in the SPA, such as specific indemnity obligations, or exceptions to the representations and warranties.)
Philipp Weber is a Corporate Partner in FPS’ Frankfurt and Dusseldorf offices and a specialist for M&A, joint venture, private equity and venture capital (cross-border) transactions. Philipp regularly acts for domestic and foreign PE and VC funds, corporations, growth companies and entrepreneurs. Contact Philipp.
GGI member firmFPSDusseldorf, Frankfurt am Main, Berlin, GermanyT: +49 69 95 957 806
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