Member Article

Maximising benefits: The importance of efficiently leveraging W&I Insurance to structure M&A deals

Warranty and Indemnity (“W&I”) insurance is a risk management tool that transfers the liability of the seller to the insurer. W&I insurance typically covers the breach of warranties and indemnities provided by a seller/warrantor and the occurrence of events that were unknown or undisclosed to a buyer. This tool can bring significant benefits to transacting parties when consideration is given to W&I insurance during the early stages of a transaction.

The consideration of W&I insurance should ideally take place before the due diligence investigations have begun and the transaction agreements have been drafted. The earlier parties have certainty as to the whether W&I insurance coverage is needed, the more efficiently the negotiations and drafting can take place.  

Importance of W&I insurance during the early stages of a transaction

A primary consideration is that insurers will only cover matters that have undergone due diligence. The coverage of W&I insurance policies will extend to that which has been investigated and verified under a due diligence. It is more effective to structure a comprehensive due diligence to identify specific risks, areas of concern and disclosures needed.

When structuring a due diligence, keep in mind that insurers and underwriters are looking for the following:-

• the appointment of reputable professional advisors to conduct the due diligence;
• comprehensive and recent legal, financial, tax and commercial due diligence reports;
• a detailed scope of the due diligence that matches the scope of the warranties requested and/or offered by both parties;
• issues that are categorised and ranked in a manner that can be easily assessed;
• due diligence reports which include materiality thresholds in accordance with market standards; and
• clear conclusions and recommendations.

Insurers rely on the adequacy of the due diligence process to evaluate the target company and this analysis will affect the insurance premium and scope of coverage offered.

Following the due diligence, parties can negotiate with the insurer to provide additional coverage. The terms of the transaction agreements can be aligned to the risk allocation provided for in the insurance policy. At this stage, parties can make an informed decision if the benefits of insuring the transaction outweigh the costs.

The W&I insurance policies can be negotiated simultaneously with the transaction agreements. The scope of W&I insurance-related provisions can be included in the initial drafts of the transaction agreements and reduce the time and costs spent on lengthy negotiations.

Exclusionary items of W&I insurance cover

The benefit of identifying the subject matter covered at the outset of the transaction will enable the parties to allocate the risk for losses in the purchase price which are excluded from a W&I insurance policy.

A non-comprehensive due diligence may result in an extensive list of exclusions provided by the insurer which include but are not limited to:

• known issues that are disclosed or identified in the due diligence report;
• fines and penalties (excluding tax);
• cybercrime;
• purchase price adjustments (leakage);
• structural defects;
• estimates, forecasts, forward-looking statements;
• anti-bribery; and
• excluded/partially covered warranties.

Importantly, the policy is tailored to meet the needs of the transacting parties and the exclusions of the policy will be specific to the transaction and its associated risks.

Benefits of W&I Insurance

In addition to the benefits of saving costs, time spent on negotiations and maintaining relationships, W&I insurance offers the following benefits:

• Clean exit

W&I insurance enables the seller to walk away without any potential liability for post-closing claims as the liabilities are transferred to the insurer. The seller can reduce its exposure to disputes and claims that may arise post-transaction. This tool is most used for private equity sponsored funds, where the seller is a special purpose vehicle set up by the fund and is wound up post transaction.

• Certainty

Parties will have certainty on matters covered by insurance and matters that will remain the seller’s responsibility. More specifically, buyers will have greater certainty of any liability exposure in relation to the transaction.

The W&I insurance serves as a benefit for the buyers to confirm the conclusions drawn from their due diligence investigations after the underwriters have assessed them.

• Coverage

Buyers are more likely to receive a market standard policy coverage in respect of the warranties, typically seven years for title and tax warranties, and three years for general business warranties.

The appreciation of this risk management tool by transacting parties will support both buyer, seller and/or warrantor by easing deal negotiations, providing comfort, and mitigating the risk of the buyer, seller, or warrantor. However, to reap the full benefit of this tool, transacting parties should engage with W&I insurance in the early stages of the transaction.  

 

Koos Pretorius

Executive Corporate Commercial

[email protected]

 

Aalia Mahomed

Trainee Associate Corporate Commercial

[email protected]