Use of Warranty & Indemnity Insurance in Private M&A Transactions

Use of Warranty & Indemnity Insurance in Private M&A Transactions

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Use of Warranty & Indemnity Insurance in Private M&A Transactions Warranties and indemnities play an important role in merger and acquisition (‘M&A’) transactions, enabling the parties to negotiate the balance of risk between them. Warranty and Indemnity insurance (‘W&I Insurance’) allows the parties to shift risk by insuring against potential breach of warranty or indemnity claims by a buyer following completion.

Simon Baker

Michael Barrington

Partner simon.baker@laytons.com +44 (0)1483 407 007

Solicitor michael.barrington@laytons.com +44 (0)1483 407 086

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Use of Warranty & Indemnity Insurance in Private M&A Transactions

Ordinarily, in a private company acquisition, all or some of the sellers or management team (‘Warrantors’) give warranties in relation to the business being sold (‘Target’). Warranties are essentially promises, the nature of which can differ depending on the sector, the parties, and the type of transaction. Generally the Warrantors will seek to disclose certain facts against at least some of the warranties in order to dilute the strength of the promises given. If a warranty is false, or has not been properly disclosed against, a buyer may have a claim against the Warrantors for breach of warranty, and can sue.

Why is W&I Insurance Used?

Parties to an M&A transaction ordinarily seek the protection of W&I insurance cover to mitigate risk under the SPA. For a buyer, it can be attractive if it has doubts about the strength of the Warrantors’ promises, or if the buyer intends to have an ongoing relationship with the Warrantors following completion. As the Warrantors often pay at least a share of the premium of any such policy, the buyer has the comfort of the insurance for no or little additional cost. This is often useful for a buyer if the threshold for Warrantors’ liability under the SPA is linked to the total threshold for cover under the insurance policy, as the buyer has the comfort of knowing that successful claims can be made up to the Warrantors’ total liability.

For the Warrantors, there are benefits where a buyer is seeking extensive, onerous or forward-looking warranties. By obtaining W&I insurance, Warrantors can effectively limit their

Certain matters may also be the subject of a specific

liability to the extent to which they are comfortable, whilst the

indemnity given by the Warrantors. Indemnities are generally

buyer can insist on the Warrantors giving stringent warranties.

more powerful than warranties, enabling the buyer to claim

Additionally, Warrantors can use W&I insurance to discourage

against the Warrantors (in principle without the need for

‘price-chipping’ by buyers, who might otherwise seek to

litigation), on a ‘pound for pound’ basis for breach, without

reduce the total purchase price if certain warranties were not

having to suffer some foreseeable loss in order to adequately

given.

substantiate a claim (or generally to mitigate the damage suffered).

W&I insurance can also benefit specific Warrantors in different ways. For example, a private equity Warrantor (i.e. who is not

W&I Insurance can be taken out by the buyer or Warrantors

involved in the business day-to-day), who may not want to

to cover losses suffered by a buyer in relation to a claim for

give extensive warranties, could achieve a clean break from

breach of warranty or against an indemnity. If the buyer takes

the Target company and ensure funds are more easily and

out the policy, it can make a claim under the insurance policy

readily returned to investors. W&I insurance allows them

for an agreed warranty claim for losses above the claims

to shift the risk of future claims to a third party, whilst also

cap in the sale and purchase agreement (‘SPA’). If the policy

avoiding placing often large proportions of the purchase price

is taken out by the Warrantors, the buyer can claim directly

in an escrow account pending expiry of the claims limitation

against the Warrantors, who then seek to recover that loss

period in the SPA.

from the insurer.

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Use of Warranty & Indemnity Insurance in Private M&A Transactions

W&I insurance can also be preferable if there are numerous sellers with varying degrees of involvement in the Target,

Conclusion

not all of whom will be Warrantors. It is not uncommon for a

W&I insurance can be a vital tool in private M&A transactions

Target that has undergone multiple stages of fundraising to

to ensure that parties are comfortable with the amount of risk

have many small investors who have little or no involvement

they are assuming. Although obtaining W&I insurance does

in its day-to-day operations, and who therefore will be

not absolve a Warrantor of adequately disclosing against

unwilling to give warranties. W&I insurance enables the buyer

warranties, or excuse buyers from undertaking an extensive

to gain the benefit of warranty and indemnity protection

due diligence exercise, it is helpful in ensuring that both

without those Warrantors having any ongoing personal

parties are able to apportion risk appropriately.

liability. This also enables sale proceeds to be released to those investors more quickly than if funds were retained in escrow following completion.

Issues with W&I Insurance Typically, insurers will ensure that certain risks are not covered by a W&I insurance policy, and therefore Warrantors may retain some liability for certain matters. For example, issues identified in due diligence, forward-looking warranties, and certain categories of warranties (such as those relating to bribery, environmental liability, or regulatory compliance) can often be specifically excluded from the scope of the policy. Policies also typically contain a minimum amount for claims (the ‘policy attachment point’), up to which Warrantors (or, occasionally, the buyer) will be liable, and insurers may also require some warranties to be capped by Warrantor knowledge.

For parties seeking to complete a transaction in a short time, W&I Insurance may not be appropriate. Not only will insurers need to review the SPA and related ancillary documents – notably the disclosure letter – which can cause some delay, they will likely also require full due diligence and disclosure exercises to have taken place.

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Use of Warranty & Indemnity Insurance in Private M&A Transactions

Corporate We advise on every facet of our client’s corporate legal needs through the complete life-cycle of an enterprise, from its inception, through its growth and expansion to, perhaps, its sale or flotation on a public market.

Our teams focus on acquiring a deep understanding of the particular needs and objectives of our clients to deliver advice and outcomes that are tailored to those needs and objectives and which meet them swiftly and cost-effectively. The approach to technical problems is informed, insightful and proportionate, and we take pride in viewing problems from a fresh perspective to provide innovative solutions.

Our Team Simon Baker

Michael Barrington

Kathryn Beasley

Partner simon.baker@laytons.com +44 (0)20 7842 8007

Solicitor michael.barrington@laytons.com +44 (0)20 7842 8086

Solicitor kathryn.beasley@laytons.com +44 (0)20 7842 8061

Martin Donoghue

John Gavan

Barney Leaf

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Partner john.gavan@laytons.com +44 (0)161 214 1653

Partner barney.leaf@laytons.com +44 (0)20 7842 8032

John McDermott

Daniel Oldfield

Jun Park

Solicitor john.mcdermott@laytons.com +44 (0)161 214 1657

Partner daniel.oldfield@laytons.com +44 (0)20 7842 8037

Solicitor jun.park@laytons.com +44 (0)20 7842 8035

Christopher Sherliker

Cameron Sunter

Liza Zucconi

Partner christopher.sherliker@laytons.com +44 (0)20 7842 8015

Partner cameron.sunter@laytons.com +44 (0)20 7842 8036

Partner liza.zucconi@laytons.com +44 (0)20 7842 8092

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This information is offered on the basis that it is a general guide only and not a substitute for legal advice.

We cannot accept any responsibility for any liabilities of any kind incurred in reliance on this information.

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