You have agreed on the valuation, the share purchase agreement (“SPA”) is in final form and you are about to close the deal, but you are told about a potential piece of litigation or the other party identifies another warranty that needs to be considered. Sound familiar?
Warranty & Indemnity (also known as Reps and Warranty Insurance) (“W&I”) can be purchased by either the buyer or the seller to plug the gaps in liability should matters, which may not have been disclosed during negotiation, come to light and that the valuation or the SPA is unable to cover.
It is often in the final stages of the deal that W&I insurance is considered and all too often, there is no time to evaluate the risks sufficiently in order to give comfort to all parties that the M&A will not unravel at some point in the future.
This article covers the key questions, buyers or sellers, in an M&A transaction should consider when purchasing W&I insurance and how it can help close the deal.
How can W&I insurance help in M&A?
W&I insurance can benefit both buyers and sellers.
For a seller, W&I insurance could limit or close off any liability to all parties once the sale is complete, thereby allowing the seller to move forward without being concerned about a future claim relating to the sale. Additionally, as a third party (insurer) is involved, the valuation will have been reviewed independently and this also gives sellers some comfort that the sale price is unlikely to be questioned in the future.
For a buyer, the main benefit is the fact that there is a third party (insurer) that not only provides an independent review of the warranties and indemnities being given but is also the party that the buyer can go to directly if there is an issue relating to the sale in the future, thereby allowing the parties to continue commercial relationships or make a clean break if necessary.
Questions to consider include:
- What is the period of time that the parties are prepared to warrant? The shorter the time period, the more effective W&I is likely to be.
- By transferring the liabilities to a W&I, will it help with valuation discussions?
- Is there existing or potential litigation that could be more securely underwritten via W&I?
- Do you want to have no further involvement once the sale is complete?
- Do you want to reduce the number of monies that are placed into an escrow account?
- Do you want to maintain a commercial relationship after the M&A is complete?
- How secure is the source of funds for the M&A?
- If you are the buyer, are there sellers, investors, shareholders, and other parties who are not prepared to assume the risks of potential liabilities?
If the answers to any of the questions set out above are yes or a likely yes, the following questions should be considered:
- Contact an insurance broker and/or insurer who specializes in W&I. There are only a small number of brokers and insurers that understand not only the product but the need to ensure the W&I is fit for purpose. Do not instruct a broker and/or insurer that offers you a ready-made W&I wording. These policies must be bespoke.
- Ask how much it will cost and how long it will take to produce the W&I wording.
- Be prepared to issue a non-disclosure agreement and ensure that any documents you provide to the broker and/or insurer are for the purposes of underwriting the W&I only.
- If there is potential litigation that you are aware of, prepare a due diligence audit of the potential litigation and/or obtain a legal opinion with a risk assessment that you can disclose to the insurers.
- If timing is tight, consider W&I insurance for specific and limited liabilities only.