Warranty & Indemnity (W&I) insurance has been on the rise in recent years and continues to gain popularity in the context of business acquisitions. These policies cover the seller’s liability for breaches of warranties given by the seller to the purchaser. Therefore it is important for entrepreneurs facing a transaction to understand what a W&I insurance is, its relevance and how it is applied in acquisition practice.
Seller vs. Purchaser
Before entering into a transaction, a purchaser initially wants to identify the risks. This will be carried out during the so-called due diligence process in which the purchaser (and his advisers) analyse the legal, financial and tax situation of the target company. Once the risks are known, the question is how they will be divided between purchaser and seller. The purchaser benefits from a comprehensive list of representations and warranties (to have sufficient security to bring a claim against the seller based on a breach of a representation or warranty); the seller logically benefits from a limited list of representations and warranties (to avert the possibility of a claim).
This creates a tension between the purchaser and the seller which can put pressure on negotiations and the relationship between the parties. W&I insurance can solve such situations: in fact, the purpose of W&I insurance is to shift the risk to a third party, i.e. the insurer, making transactions easier to conclude.
Who concludes the W&I insurance policy?
W&I insurance is an insurance policy. The question then arises who concludes such policy: the purchaser or the seller.
In practice, W&I insurance policies are most often concluded by the purchaser. If the purchaser suffers any damage (which can be recovered from the seller), the purchaser can approach the insurer directly. Thus, the purchaser does not have to approach the seller first, and payout under the policy does not go through the seller’s equity.
If the seller concludes the W&I insurance, the seller is the policyholder. Such policy is much less common. In this case, the purchaser has to approach the seller directly to get his or her losses compensated. The seller only enjoys protection under the policy against claims by the purchaser in the second instance.
Certain transactions are characterized by the seller’s demand to be left with as little liabilities as possible, a so-called “clean exit”. For instance, a seller wants to retire after selling his business and wants to worry as little as possible about the warranties he had given in that context. In this case, the W&I insurance provided a suitable solution to bridge the gap between purchaser and seller.
Another practical case where W&I insurance can be a useful tool is in the context of a sale process where several interested purchasers can bid for the company. In such a case, a bidder can distinguish itself from other bidders by making its bid conditional on the conclusion (by the bidder) of a W&I insurance. This makes the bid more attractive as it limits the seller’s liability.
Are you (as a purchaser or seller) facing a business transaction and wondering whether a W&I insurance is an appropriate tool?