Why warranty and indemnity insurance is on the rise

The use of warranty and indemnity (W&I) insurance to smooth the path of mergers and acquisitions (M&A) deals is on the rise in Ireland. These policies offer an innovative means of dealing with the risks inherent in such deals and help speed up the sale process.

"A central theme in all M&A transactions is risk," explains Oisín McLoughlin, corporate senior associate with law firm Pinsent Masons. "Inevitably, when the parties get into the nitty gritty in the sale and purchase documents, unless well managed earlier in the process, questions will arise as to who will be liable for certain risks that are baked into the business. The well-trodden path is that a seller will give a number of contractual promises as to the condition of the target, known as warranties, and if these promises turn out not to be true the seller has to make good to the buyer the difference between what the buyer paid for the target and what it is actually worth."

A seller may also have to give indemnities for certain fundamental risks and make good on a euro for euro basis the liability or cost that could arise from them.

Sellers may not be willing to offer such warranties and indemnities and buyers, although wanting to do a deal, may not be able to proceed without some comfort in relation to risk. This is where warranty and indemnity insurance comes into its own.

The policies insure the risks identified during the sale process and usually have a limit of between 10 per cent and 30 per cent of the overall value of the company being sold. However, in the case of smaller companies this can be much higher and may rise to 100 per cent. The policies usually include an excess amount, similar to standard home or motor cover, but this can be shouldered by the buyer or seller.

W&I policies can either be held in the name of the seller or the name of the buyer. However, according to Howden, a UK-based broker specialising in this area, more than 90 per cent of policies are held by the buyer with the question over who pays the premium being decided during the deal negotiations.

"Having the policy in their name allows the buyer to claim directly against the insurer without having to first seek recourse from the seller," says Niall Campbell, insurance senior associate with Pinsent Masons. "This helps to facilitate clean exits for sellers and gives buyers the comfort that in the event of a claim their recourse is against an A-rated entity."

Private equity buyers

According to the recently published Pinsent Masons, Livingstone and Howden 2019 report on Private Equity and M&A deal trends, 41 per cent of UK transactions had cover taken out by the buyer (with the figure rising to 59 per cent for private equity buyers).

“W&I insurance is commonplace in the UK,” Campbell notes. “The market there is relatively mature, with over 25 insurance providers offering it.”

The use of W&I insurance is still in its early stages in Ireland, but this is changing, according to McLoughlin. “Since October 2018, Howden has been involved in five Irish law governed transactions that have successfully completed where W&I insurance was taken out. In Ireland, our experience is that the awareness of W&I insurance is growing, as are the chances of it being considered by parties to transactions.”

Misconceptions in relation to cost, complexity and the claims process are being overcome. “We are seeing an increasing number of deals in Pinsent Masons in Dublin where W&I insurance is being used because it is proving to be cost effective and straightforward to put in place,” he adds. “There is also a growing understanding that valid claims will be met.”

And increased competition is driving down the cost, according to Campbell. “A number of US W&I insurers have entered the European market and Howden reports that this is placing downward pressure on premiums. They are also increasing competition by offering enhancements which are more typically found within the US market, such as non-disclosure of data rooms and due diligence reports.”

The advantages offered by W&I are too significant to be ignored, McLoughlin concludes. “It can get around deadlock situations where the parties cannot agree who should be responsible for the potential, latent risks associated with any transaction,” he says. “It also increases returns for sellers because it is can create a clean break scenario as any claims down the line are dealt with by the insurer. From the buyer’s perspective it obviates the need to make claims against management which is particularly helpful for private equity investors who typically see management as partners in the business and not a party whom they want to litigate against. We have seen W&I insurance used in both private equity and non-private equity transactions in Ireland and in flexible ways. It is an innovative and a welcome addition to the menu of options parties use to get deals done.”