What is W&I Insurance?
Warranty and indemnity (W&I) insurance is an insurance product developed for the mergers and acquisitions market. The product insures against the risks of a breach of a warranty or indemnity in a sale agreement. It is intended to transfer the risk of financial loss associated with a claim for a breach of an insured warranty or indemnity from the seller to the insurer. Policies may be procured by either a seller or buyer. Most W&I policies in Australia are buy-side policies.
A buy-side policy provides the buyer with direct recourse to the insurer for a breach by the seller of an insured warranty or indemnity. Premiums can be paid by the buyer or seller (or both) and often form part of the price negotiations between the parties to the transaction. Premiums on W&I insurance policies in Australia are negotiable but tend to be between 1.2% and 2% of the quantum of the insured risk. These have been rising over the past 12 – 18 months due to a range of factors including increase in M&A activity, popularity of product and underwriter capacity restraints. Premium costs are often shared between sellers and buyers given the benefit of the product to both parties but this can depend on the negotiating power of the parties in the underlying M&A transaction.
Why use W&I Insurance?
There are several reasons to purchase W&I insurance including the following:
|Private equity funds and other sophisticated investors may view W&I insurance as a tool to facilitate a clean exit and provide greater certainty of the extent of any liability exposure associated with the transaction.
|W&I insurance may provide a buyer with confidence in its ability to recover for a breach of warranty or indemnity (as the insurer’s balance sheet will effectively replace any perceived credit risk associated with the seller). This may remove the need for an escrow or deferral of purchase price.
|The existence of W&I insurance may provide a prospective financier of the buyer with the comfort it requires to provide the debt component of a purchase price.
|A buyer may enhance its proposal in a competitive tender process by structuring W&I insurance into its bid.
|Founder / Management
|If the seller or its representatives (e.g. a founder) are employed by the target post acquisition, the buyer may want W&I insurance so that it can make a claim directly with the insurer, effectively preserving the relationship with the founder / management team, who will likely still be managing the business post-completion.
|Liquidators and administrators may want to provide greater comfort to purchasers of distressed assets by offering W&I insurance as a component to the transaction.
|A buyer entering a new jurisdiction may want certainty about its ability to recover for breach of warranty or indemnity under the transaction documents. Equally, a seller exiting a jurisdiction may want certainty about its liability exposure in that jurisdiction.
|A buyer may be concerned with its ability to recover on a claim against multiple sellers, particularly in circumstances where they are located in different jurisdictions
The process and timeframes involved in putting a W&I insurance policy in place can vary. This will depend on the timing of its introduction into the transaction process, but it will usually take a minimum of two weeks. Timeframes for the negotiation and finalisation of W&I policies are often tight.
What is covered?
The product aims to sit back to back with the warranty package in the associated sale agreement, insuring warranties and indemnities (excluding specific indemnities that capture known risks) such as:
- Title and capacity warranties;
- Business warranties;
- Tax warranties;
- General indemnity;
- Tax indemnity; and
- GST or tax gross up.
Sale agreements will contain provisions outlining that the buyer’s sole recourse in respect of any warranty or indemnity claim is to the insurer unless it arises because of the fraud of the seller. Depending on the negotiating power of the parties, these exclusions can be extended to cover breaches of fundamental warranties (e.g., title and tax) or warranty or indemnity claims that are more than the insured limit.
In terms of liability of a seller for breach of a warranty or indemnity, the share purchase agreement and W&I insurance policy will contain provisions that the underwriter is only entitled to subrogate against the seller in respect of any payment made under the W&I insurance policy that arose directly out of the seller’s fraud.
What is not covered?
W&I insurance typically excludes (by way of example):
- known or disclosed risks;
- forward-looking warranties;
- warranties in areas where extensive due diligence has not been undertaken;
- environmental issues (it may, however, be possible to obtain additional specialist cover);
- criminal or civil fines or penalties;
- consequential loss;
- fringe benefit tax of companies;
- underpayment of payroll tax (unless appropriate due diligence, such as an acceptable payroll sampling exercise, has been undertaken); and
- cyber incidents or non-compliance with data protection legislation.
W&l insurance is used to cover unexpected issues, but only on the premise that the buyer has already performed extensive due diligence (e.g., financial, legal and tax). If due diligence has not been performed, then coverage will not be available. If there is any indication that the due diligence is incomplete this could result in further coverage exclusions and/or premium increases.
Sell Buy Flip
A sell buy flip is where a seller will work with an W&I insurance broker at the start of a sale process to go to market and obtain terms of coverage from several underwriters. A broker will require draft vendor due diligence reports and a draft sale agreement from the seller prior to reaching out to insurers. Once indicative terms (scope of coverage and premium ranges) are available, they are provided to prospective bidders.
Once a bidder is successful, the broker’s relationship will “flip” to working with the buyer to ensure the policy is fully underwritten and in place at the time the transaction signs.
Sell buy flips are a useful tool in streamlining competitive sale processes, but vendors should be mindful of the associated costs of preparing vendor due diligence reports and a draft sale agreement.
The inclusion of W&I insurance is largely dependent on the nature of the transaction and a variety of different factors as outlined in this article.
It is important to factor in the time that it can take to obtain W&I insurance in the timetable for a transaction, particularly during busy periods (such as end of calendar year and the end of financial year) where it can take longer to obtain a policy due to capacity constraints.