M&A activity assisted by insurance products

W&I insurance-or warranty and indemnity insurance-used to be very much a concept for corporate M&A in excess of £100 million. Over the past four or five years, the affordability of the premiums mean that this is now a very real consideration for any transaction in excess of £10 million.

In most corporate deals, sellers are required to give warranties that certain information about the target company or group is true and accurate at the point of sale. If it then transpires after completion that there were unknown and undisclosed risks and liabilities that sit within the target company, the buyer will often have the right to claw back some or all of the purchase price from the sellers, perhaps up to 6 or 7 years after the sale has completed.

Warranty and indemnity insurance can now be taken out which will provide cover for any claims like this. There is of course a cost to taking out this cover; but as a rough rule of thumb, the premiums sit at around 1 to 1.5% of the level of cover (plus IPT) . This gives sellers the advantage of knowing that their sale proceeds are, in the absence of fraud on their part, “safe”, leaving them free to spend their cash on that long awaited superyacht!

There are also advantages to buyers in having W&I in place;

• PE houses will never give a full suite of warranties;
• often silent investors or shareholders who are remote and not involved in the management of the business (e.g. EIS investors) will also refuse to give warranty cover.
• The (in)solvency of some sellers may also mean that any enforceable warranty cover given by them may be questionable.
• If a buyer continues to employ or co-invest alongside shareholders who have given warranty cover,(eg in MBO scenarios) they are often reluctant to try and recover any of the purchase price from the very people they are trying to incentivise, going forwards.

If insurers cover this risk, the buyer will be in a better position. It is for this reason that it is more common for buyers to take out what is known as a “buy side policy” and often this is a condition in a seller-led bidding process in auction-type transactions.

Insurers and underwriters of these policies will want to know that a rigorous due diligence and disclosure process has been performed on an arm’s-length basis, and due diligence reports from reputable professional advisers will often need to be supplied to those underwriters. The buying team will often have to complete a “No Claims Declaration” confirming that they have no knowledge of any breaches of warranty other than those set out in the disclosure letter or as highlighted in the professional due diligence reports.

Amanda Brockwell has been involved in half a dozen transactions over the past 2 years which have involved W&I insurance and has seen the developments of the product to address market requirements. She commented:

“The level and period of cover, any policy excess and excluded areas of cover are all up for negotiation and it is possible to get cover for known disclosed risks, so there is a full range of flexibility to the insurance products available. Key to this is to make sure that you have an experienced broker in this sector and advisers who understand the product”.

There are also policies which mean that the insured buyer negotiates the warranty and tax covenants direct with the insurer rather than the sellers – known as “synthetic warranty schedule and tax covenants”.

Some risks are invariably not covered by standard policies – environmental and pollution liability and any concerns relating to land and buildings with asbestos. Cyber incidents, pension scheme liabilities and civil or criminal fines, penalties and tax risk arising from trading between group companies often fall outside the scope of cover.

Undoubtedly, there are a fair number of transactions that would not have proceeded, or would have proceeded but at a much reduced purchase price, had W&I not been available, so buyers or sellers should always consider this at an early stage.