Product Fundamentals: Warranty & Indemnity (“W&I”) insurance

Merger and acquisition (“M&A”) activity is increasing in the current economic climate. With this trend, it appears companies are becoming more inclined to transfer the risk of such transactions under W&I.

This product provides peace of mind to purchasers and sellers which limits their financial exposure in the event an indemnity is triggered for a breach of warranty under a share sale agreement, or similar transaction instrument.

Cover is specifically tailored for each deal. In addition to its usefulness to transfer risk, the process of underwriting a W&I policy is often considered a prudent risk management tool to address parties’ concerns of a transaction. It may also be used strategically by the transaction parties to achieve a quicker, clearer and more efficient deal.

Forms of W&I
‘Sell-side’ W&I
Covers the seller against claims made by the buyer for alleged breach of warranty under the sale agreement. The seller benefits from the cover - in a practical sense - by not having to return a portion of the purchase price to the buyer as a result of the breach.

‘Buy-side’ W&I
Covers the buyer for losses arising from breaches, inaccuracy and misrepresentation by the seller in the sale agreement. A ‘buy-side’ policy will also cover claims alleged by the buyer that allege seller fraud; such cover is not offered to the seller (for its own fraud) under a ‘sell-side; policy. The benefit to the buyer is that it is reimbursed for losses directly by the insurer without having to first seek recourse against the seller. The insurer still retains it right of recovery against the seller to recover its losses.
Process of procuring W&I cover

To understand the nature of each deal and obtain interest from underwriters, typically the information sought by the intermediary will include: whether ‘buy-side’ or ‘sell-side’ cover is required; the parties to the deal and their respective advisors; the deal size and how it has been calculated; any heads of agreements or memorandum of understanding between the parties showing wider structure and parameters of the transaction; any information memorandum, management presentation or other marketing document; and the proposed timetable for the deal.

At this point, indicative quotations are sought by interested underwriters. Therein they indicate premium and their underwriting due diligence fees. Depending on the insurer and deal size, these fees may vary. The fees comprise legal costs intended to be incurred by insurers to review the “disclosure material” associated with a deal, confer with counsel of the buyer and seller, and manuscript the policy to match the warranties and indemnities in the transaction agreement. The underwriting due diligence fee is not refundable if the deal does not proceed or the policy is not purchased. On occasion the expense may be deducted from the premium.

Once the insurer is selected, an expense and non-disclosure agreement is entered into. Once executed, the insurer and its lawyers are given access to the deal data room and underwriting due diligence commences. A number of meetings are held amongst legal representatives of the parties (insurer, seller and buyer) to finalise due diligence and otherwise set the terms of cover. In the ordinary course, the advisor sourcing the cover attends those meetings.

Bellrock’s role in arranging W&I cover
In the deals that we have been involved with we:
  1. ensure that we select the most appropriate and cost-effective insurer - commensurate to the size and nature of the deal

  2. advise on the appropriateness and adequacy of the policy limit. In doing so, we have regard to:

    • risk tolerance commensurate to the deal;

    • nature and status of entities to the deal;

    • market trends regarding policy limits;

    • the extent of the due diligence process and qualifications in connection with same; and

    • “other” insurance held by the seller/buyer which may complement the W&I policy.

  3. ensure that the scope of the W&I matches the warranties in the sale agreement and otherwise advise on relevant policy exclusions

  4. advise our client in relation to “other insurance” issues in the course of due diligence, in particular the efficacy of existing covers and the extent to which those covers may need amending, endorsing or to be placed into run-off. It is relevant here that sellers should ensure they have in place adequate and appropriate directors’ and officers’ liability; buyers also should require that such cover is maintained by sellers for 7 years post date of the transaction – for additional information see our article on claims made insurance (located here).

  5. continue to review and monitor the outcomes and milestones of the transactions, and if necessary extend policy periods or otherwise endorse policies if required

  6. manage any claims and or notifications made under the policy arranged.

To discuss your insurance needs with one of Bellrock’s experienced advisors, please contact us via the form below.

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