Warranty & Indemnity Insurance – Strategic Applications in Global Transactions

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Since the onset of the global financial crisis, an increased focus on risk has manifested itself in many segments of global business.  This article focuses in particular on the risks associated with merger and acquisition transactions and the use of Warranty & Indemnity Insurance (“W&I Insurance”) and other unique transaction related insurance products to mitigate risk.

Chris Ball is Vice President of Reliance Insurance Agencies, Ltd.  He can be reached at 604-251-8322 orcball@reliance.bc.ca 

Mark Johnson is Account Executive at Reliance.  He can be reached at 604-251-8360 or mjohnson@reliance.bc.ca 

Reliance represents Equity Risk Partners Global in Vancouer

W&I Insurance has its roots in the London insurance market dating back to the 1980’s, when it was first utilized to provide a source of indemnification in merchant bank and venture capital backed transactions.  Warranty & Indemnity Insurance, initially written as a Seller-side insurance policy, was created to provide a source of indemnification for breaches of the Seller warranties provided by management of the target business. 

The product has evolved substantially since its formative days, and now is utilized to resolve indemnification issues in a variety of merger and acquisition contexts, and underwritten both with Buyer-side and Seller-side policy forms.   The market has experienced a sizable increase in utilization of W&I Insurance (or Representations & Warranties Insurance as it is commonly called in the U.S.) over the last couple of years.   This can be attributed to a number of factors, including:

  • an increased emphasis on, and reduced tolerance, for risk by parties engaged in M&A transactions;

  • substantial improvement in the insurance product to the point where more M&A principals, and their counsel, are comfortable that the product provides meaningful risk transfer; and

  • improved pricing as insurers have experienced profitable underwriting results which has attracted new entrants into the space.

One area where W&I Insurance can provide particular value to parties is in the context of cross-border transactions.  Several transactional insurance providers have developed global underwriting platforms with the ability to underwrite W&I Insurance in many jurisdictions around the globe, including Europe, North and South America, Asia and Australia.  In cross-border transactions, the dynamic of investing in a foreign business often presents a heightened concern by buyers due to unfamiliarity with the legal, regulatory and business environment.    This tends to increase the probability that the parties will have divergent views on indemnification issues, including as relates to negotiation of indemnification escrows, caps and survival periods. 

In terms of specific examples, a U.S. private equity firm was acquiring a family owned business in Europe as an add-on to one of its portfolio companies.  The target was in at least its fourth generation of family ownership.   Our client negotiated a reasonable escrow from the sellers, but due to its unfamiliarity with the legal and business environment, coupled with several generations of family ownership, wanted increased indemnification protection in the event of unforeseen issues with the business or its capital structure and title to shares.   To obtain this comfort, a Buyer-side W&I Insurance policy was purchased which provided indemnification above the escrow and extended the survival of all representations and warranties to a 6 year survival period.  

In another situation, a private equity firm was negotiating to acquire a business in Australia.  The target was extremely attractive to the private equity firm, so the firm wanted to distinguish its bid.   A buyer-side W&I Insurance policy allowed the firm to limit the sellers’ indemnification to fraud while still obtaining the level of indemnification protection desired.   This approach led to a successful bid and the transaction closed with W&I Insurance in place, following extensive negotiations to obtain the proper policy wording to tie the policy to the acquisition agreement, and include several manuscript enhancements to coverage.

Accordingly, W&I Insurance can be effectively utilized to bridge the gap on indemnification and facilitate closing of the deal, with both parties still achieving their core objectives on indemnification.  From a foreign buyer’s perspective, this could mean obtaining indemnification protection, on what the buyer deems are critical warranties with respect to the target business, while allowing the sellers to limit exposure to indemnification.   In some cases the buyer may want protection as high as the purchase price.  From a seller’s perspective, W&I insurance may allow for a cleaner exit from an investment without having to tie up funds or hold reserves for potential indemnification claims for long periods of time after closing.

The most significant recent trend is the use of W&I Insurance by buyers on foreign acquisitions as a means to obtain a competitive advantage over rival bidders.   With the cost of W&I Insurance often in the range of 1 to 2 percent of limits purchased, a buyer can incorporate W&I insurance into the transaction and limit the seller’s indemnification to a relatively low cap, or in some situations completely replace seller indemnification.  This may be enough to tip the deal towards the buyer when another bidder with a similar valuation is requiring a standard indemnification structure. 

Successfully incorporating W&I Insurance into a transaction requires a team effort involving a knowledgeable insurance broker sophisticated in negotiating manuscript terms and properly coordinating with deal counsel to ensure that the W&I Insurance is properly structured to work in the context of the acquisition agreement.   Some of the key issues to address in any W&I Insurance placement include appropriate language around “knowledge” of the buyer and seller, as well as important policy terms such as how “loss” is defined, subrogation, terms and conditions of coverage, and any policy exclusions.   

Chris Ball is Vice President of Reliance Insurance Agencies, Ltd.  He can be reached at 604-251-8322 or cball@reliance.bc.ca. Mark Johnson is Account Executive at Reliance.  He can be reached at  604-251-8360 or mjohnson@reliance.bc.ca.  Reliance represents Equity Risk Partners Global in Vancouver.

Equity Risk Partners Global is the first and only international insurance brokerage alliance focused exclusively on the needs of the private equity marketplace. Comprised of independent brokers in countries with a significant amount of private equity activity, this worldwide consortium is dedicated to improving the efficiency, structure and return of private equity transactions through a unified and consistent approach to due diligence and client service.  For more information, visit www.equityriskglobal.com.