Buying or selling a company? W&I insurance – is a key consideration in every deal.

Let’s look at a scenario where you may need warranty & indemnity insurance.

You’re a business owner selling the company you worked hard building over the years. You are excited to move on to the next adventure. You’ve found a buyer, Alex, who is thrilled to take over and grow the business. 

You’ve signed a Share Purchase Agreement, which has warranties. These cover everything from financial statements to employee details. This assures Alex the company is in good shape. 

You know your business well, but what if after the sale an issue crops up you didn’t know about? Like an undisclosed tax issue, or an incorrectly reported contract. These issues could lead to Alex claiming losses from you once you’ve already moved on. 

This is where warranty & indemnity insurance can come in to help. It gives you protection that any claims made by Alex will be covered by an insurer instead of you. This also gives comfort to Alex that they have insurer protection rather than having to pursue you for a claim. 

Comfort for both buyer and seller, warranty & indemnity insurance transforms transactions and any potential risky issues into a smoother deal. 

Let’s take a closer look! 

What is W&I insurance- in more detail

When a company is being sold, the central governing contract (the Share Purchase Agreement, or “SPA”) generally includes warranties about the company’s condition at sale.

If any of these warranties prove to be untrue or if there’s a tax issue, the buyer can make a claim against the seller for financial losses.

In practice what this means is that the seller remains liable for a significant amount of the purchase price. This liability persists for a long period of time after the sale.

W&I insurance changes this situation by transferring liability from the seller (or party giving the warranties), to an insurer. This allows the seller to have minimal liability and a ‘clean exit’ from the sale. 

Types of W&I insurance 

There are two types of warranty & indemnity insurance policies: (i) buy-side; and (ii) sell-side. Although most of the insurance policies are buy-side. 

Buy-side W&I insurance 

In buy-side warranty & indemnity insurance, the buyer is insured. If there’s a breach of warranty, the buyer can claim directly against the insurer. This avoids the need to take any action against the seller. When W&I insurance is used, the SPA will typically require the buyer to seek recourse from the insurer rather than the seller.

Generally, this allows sellers to significantly reduce their liability and have a ‘clean exit’. The buy-side W&I policy becomes the main (if not sole) recourse of buyers for any claims after completion of the company sale.

Sell-side W&I insurance 

In sell-side W&I policies, it is the seller who is insured. Sell-side W&I policies protect sellers if they face a claim under the SPA and have to pay damages to the buyer. The insurer reimburses the seller for claim payments and defence costs. 

Key benefits

Protect sale proceeds – for sellers, W&I insurance safeguards their sale proceeds from post-closing warranty claims. It also covers any related defence costs. 

Clean exit – sellers requiring a clean exit from a business sale can offer/request a buy-side policy. This is recommended as opposed to the seller being on the hook. 

Buyer protection – buy-side policies provide buyers with the certainty. Any SPA losses suffered will be covered by a reputable A-rated insurer.

Bid differentiation – buyers in competitive auctions can use buy-side W&I policies to offer more favourable bid terms. These include reducing the seller’s SPA liability cap.

Increased deal speed – W&I policies streamline negotiations allowing parties to focus on bigger-picture commercial issues rather than full-scale negotiations. 

Maintains relations– Having insurance in place can ease the tension. This is especially true when former owners or management continue with the company after the sale.

Frees up capital – insurance can be an effective alternative to other mechanisms which lock up capital- like escrow.

Key elements of a W&I policy

Policy limit – the maximum the policy will pay out, often between 10-30% of the deal value.

Policy Period – the period of cover the policy provides. Usually 2-3 years for general warranties and 7 years for fundamental, tax warranties, and tax indemnity.

Deductible – aka the ‘retention’ or ‘excess’, the one-off monetary amount the insured party must cover before the insurance kicks in. 

Premium – this is the cost of the insurance policy, a one-off payment for the entire policy period. Insurance taxes (determined by the insured’s jurisdiction) are also payable.

Exclusions – W&I policies aim to provide back-to-back cover with the SPA. However, there are some mandatory exclusions which apply, such as 

  • Known issues of the buyer 
  • Fines, penalties, and matters uninsurable by law 
  • Fraud of the insured 
  • Purchase price adjustments 
  • Transfer pricing, secondary tax liabilities, availability of tax assets

Each deal may also have additional, deal-specific exclusions on top of the mandatory ones.

Process of obtaining a W&I policy 

Typically, lawyers are heavily involved in the process, as well as a W&I insurance broker.

  1. Marketing phase – Information (eg draft deal documents) are sent out to multiple insurers for initial terms, or ‘non-binding indications’. Clients review these and select an insurer to proceed with.
  2. Underwriting phase – The chosen insurer reviews due diligence reports and disclosure materials, sometimes with underwriting calls for clarification.
  3. Finalising policy – A draft policy is provided by the insurer. After any necessary negotiation, it will incept at the same time as the M&A deal completes. 

Total time – This process generally takes around 10 days but can be expedited if necessary. Although, the earlier insurers are approached in the deal process, the better! 

What affects the cost of W&I insurance?

The current UK rate ranges between 0.6%-1.5% of the policy limit chosen. The cost of a W&I policy is impacted by a range of factors, such as:

  • Policy limit size: Larger policy limits mean higher premiums.
  • Deal value and complexity: The larger and more complex the deal, the higher the premium.
  • Deductible Level: Lower deductibles typically lead to higher premiums.
  • Legal/Underwriting Fees: Insurers may charge additional fees for using external counsel.
  • Additional coverage enhancements: extra coverage features may impact cost too.

Insurer assumptions

There are certain assumptions on which W&I insurers base their offer of coverage. Essentially, W&I insurance is meant to cover unexpected issues that emerge after completion of the business sale. It does not cover matters that should have been revealed during negotiations. Here are the main assumptions which should be kept in mind:

  • Arm’s Length Negotiation: The deal should be negotiated fairly, with balanced warranties and reasonable seller limitations.
  • Informed Sellers: Sellers should have enough knowledge of the business and actively participate in the disclosure process.
  • Due Diligence for Buyers: In buy-side policies, the buyer is expected to perform thorough due diligence. This should align with the warranties and scope of the target business’ operations.
  • Seller Liability: Sellers should have some liability in the SPA (even if nominal). This enables insurer recovery in cases of seller fraud.
  • Reasonable SPA Terms: The SPA should have fair terms. These include a reasonable scope for the seller’s knowledge and a practical definition of “disclosed” information.

Key takeaways 

  • W&I insurance provides a safety net for M&A transactions by transferring liability from the seller to an insurer. This product is essential for buyers and sellers alike. It ensures smoother deals, mitigates risks, and helps parties focus on their business. Starting the process early in the M&A timeline is advisable. Even if it’s uncertain whether insurance will be purchased, this allows both parties to assess coverage needs and address any potential gaps in advance. 
  • W&I insurance is not a replacement for adequate due diligence or a proper disclosure process. Insurers will expect both to have been undertaken to a satisfactory level with appropriate scope and thresholds.
  • There will be mandatory exclusions which apply to every policy, and sometimes deal-specific exclusions. 
  • The cost of W&I insurance depends on the deal and specifics on the target. The party which bears the cost of the premium is a point of commercial negotiation. 

Thank you to Miren Patel of Windemnity for this article.