In the context of a share purchase, the seller provides certain warranties and indemnities to the buyer. Common warranties include, among others: the existence and unencumbered ownership of the shares being sold, the accuracy and continuity of the financial statements, ownership and freedom from encumbrances of intellectual property rights, ownership, freedom from encumbrances, and usability of fixed assets, continuity and validity of key contracts, adequate and valid insurance coverage, absence of environmental risks, absence of legal or administrative disputes, and the existence of public-law permits.
This catalog of warranties is tailored to each transaction and represents a key negotiation topic, particularly regarding: type of warranties, liability caps, liability periods, and securing compensation claims resulting from a breach of warranty. To avoid weeks of negotiation over the warranty catalog, purchase price retentions, escrow accounts, or bank guarantees—and to prevent them from becoming potential deal-breakers—there is the lean solution of W&I insurance, short for Warranties & Indemnities.
What is W&I Insurance?
The insurance covers unknown risks (and, if desired, also known risks where the financial impact is uncertain) arising from warranty breaches. W&I insurance protects both the buyer (first-party loss coverage) and the seller (liability coverage), transferring risks from the respective balance sheet of the buyer or seller to that of an insurer or consortium of insurers.
The duration of insurance coverage generally follows the contractually agreed warranty period. The scope of coverage is primarily a cost-benefit issue but should largely align with the purchase agreement.
Process of W&I Insurance in an M&A Transaction
Either the seller or the buyer may initiate a W&I insurance policy. In both cases, the process generally looks as follows:
- Signing of a confidentiality agreement with a broker
- Provision of transaction information to the broker (SPA draft is recommended)
- Broker approaches insurance companies
- Broker presents an overview of offers
- Selection of the insurer
- Insurer conducts a non-intrusive due diligence (e.g., buyer’s DD reports are provided)
- Insurer submits a binding offer
- Contract execution (approx. 2–4 weeks after initiation)
If the seller arranges the insurance, he remains liable under the purchase agreement warranties to the buyer and can only subsequently seek recourse from the insurer. This has several disadvantages, such as:
- Buyer must pursue the claim against the seller(s)
- No joint and several liability if there are multiple sellers
- Seller may lack solvency to cover damages
- Seller may be unreachable
- Insurer may reject the claim, leaving the seller exposed
As a result, “Stapled Insurance” has become increasingly common. In this model, the seller initiates the W&I insurance process and provides bidders with a non-binding insurance offer. The final negotiations are then conducted by the buyer, who becomes the policyholder. This approach ensures that W&I insurance does not become a bottleneck in the final stages of the transaction and creates a clean cut between seller and buyer.
Costs
The cost of W&I insurance typically amounts to around 1.5% (+/- 0.5%) of the coverage amount, with many insurers setting a minimum premium of approximately €50,000. The deductible is usually about 1% of the enterprise value.
The insurer expects a minimum level of due diligence. While this may increase transaction costs in some cases, it also means that W&I insurance becomes economically viable only from a certain minimum transaction size.
If (industry-)specific risks outside the “standard” program are to be covered (e.g., warranty for unknown environmental damages in an oil-processing company), the premium can increase significantly.
W&I Insurance in Light of the COVID-19 Crisis
The visible consequences of the crisis for M&A processes include smaller pools of bidders, slowing of ongoing processes, and the postponement of new processes for the time being. Looking at ongoing processes, W&I insurance cannot eliminate the uncertainties of the current situation but can provide security for the period after the transaction. By reducing uncertainty, W&I insurance serves as a valuable building block on the path to a successful transaction.
For questions about W&I insurance, your i-capital team is always happy to assist you. Contact us!
