Warranty and indemnity insurance (W&I) was first utilised in mergers and investments in the UK around 20 years ago and nowadays is increasingly used for ‘peace of mind’ in the sale of smaller companies. As its popularity is growing once again, it’s important that advisers are up-to-speed with W&I and able to advise their clients. Graham Spalding, a partner in the corporate and commercial practice at law firm Lodders, explains more.

With reports of the use of warranty and indemnity (W&I) insurance in corporate mergers and acquisitions (M&As) on the rise in the UK, it is relevant and useful to look at what W&I insurance is and recent trends in its usage.

What is warranty & indemnity insurance?

W&I insurance is a specialist single premium insurance designed to provide cover for losses incurred from breaches of representation, resulting in warranty or indemnity claims, which might occur during a merger or acquisition. Each W&I policy is unique, allowing it to be tailored to the specific requirements of the transaction.
When a business is sold, a seller is usually required to give various warranties to the buyer.

Warranties are statements of fact about the target business, which gives the buyer two main protections:
1. Help to flush out information which is inconsistent with the warranties that the seller is asked to give, and,
2. Give the buyer a contractual right to bring a claim against the seller in the event that they suffer losses in circumstances covered by a warranty.

Either party in a transaction can take out W&I insurance, but it is typically the buyer who will purchase this type of insurance – it is often agreed to split premium costs between the two parties.

When a policy is taken out by the buyer, the buyer has the ability to claim against the seller up to an agreed level of liability, as stated on the transaction documents – this can be as little as £1. Once the liability exceeds that which has been agreed between the parties, the buyer can then claim against the insurance policy to cover any additional losses.

If the policy is taken out by the seller, however, the buyer has no direct claim against the insurance company and must claim against the seller. In this case, the seller remains liable, but the insurer controls any defence and/or settlement of the claim.

The rise and fall of W&I

Twenty years ago, the use of W&I was increasing, being particularly relevant in situations when the sellers would not or could not give warranties, for example Private Equity sellers.

The W&I insurance provided the buyer with security on its acquisition and helped to negate any potential risks in the business where warranties were not available. The premia for this specialised insurance increased to as much as five percent of the risk insured (usually a percentage of the sale price), at which point, given the lack of claims being made, demand started to fall away.

Over the last 10 years, however, use of W&I insurance has increased again as premium rates have come down to as little as one percent, with multiple new entrants to the market seeing the returns that can be made. Its use has increased in private company sales, where the insurance can provide sellers with the ability to 'rest easy' having sold, knowing that in the unlikely event of a claim, the insurance will respond, and they will not have to put their hands in their pockets.

The market has shifted so that most policies are now non-recourse, buyer policies - which allow the buyer to seek recovery directly from the insurer under the policy without first claiming against the seller.

We have seen stapled W&I policies in auction sales, similar to stapled debt packages.

And finally, nowadays, we are seeing W&I policies with no excess for the sellers to pick-up, which is of course adding to popularity.

Opinion

Personally speaking and as a M&A specialist, we need to be aware of the potential availability of W&I insurance as a way to provide a route through the M&A process.

It can provide a solution where sellers cannot or will not provide warranties of value in the M&A process. However, there is a cost, and exclusions will apply, so its use will depend on the merits, and clients can sometimes be better advised negotiating a reasonable set of warranties and undertaking a thorough disclosure exercise.

More information

For more information, contact Graham Spalding, partner in the corporate and commercial practice of Lodders Solicitors, email: graham.spalding@lodders.co.uk Tel: 01789 206162, visit: www.lodders.co.uk.

Lodders’ team of corporate and commercial solicitors offers accurate, focused and solution-based legal advice to a wide range of clients, from long-established owner-managed businesses, family businesses, and SMEs, through to charities and not for profit organisations. Kim Klahn specialises in advising on all company and commercial law matters and is a specialist in non-contentious employment law.

Graham Spalding joined Lodders earlier this year as an Equity Partner to drive strategic growth of the firm’s corporate and commercial law services, working alongside Kim Klahn, head of Lodders Corporate and Commercial team in its Stratford upon Avon office.

A senior M&A lawyer, Graham has over 25 years corporate and private equity experience, acting for corporate, private equity and owner managed clients in sectors including pharma, manufacturing, light industrials, and professional services.

Prior to three years at London firm RPC, Graham was at Wragge Lawrence Graham & Co (now Gowlings) in Birmingham for 17 years, after six years at Eversheds LLP.

Note: The opinions and views in this article are for information only and do not constitute legal advice.

Tags: UK200

Back to Blogs