W&I Insurance Starter Pack
Once seen as a trend, W&I deals have become increasingly popular over the last decade or so – more recently as a way of dealing with liability on acquisitions in a pandemic scenario. If you’ve never been involved in one of these deals before or have only limited experience of them, read on to find out the basics.
A “standard” corporate acquisition
You might be familiar with how corporate acquisitions generally run:
- The buyer conducts due diligence on the target company (the “Target”).
- The parties negotiate sale terms in the sale and purchase agreement (the “SPA”), which include a set of warranties (akin to promises regarding the Target) that are given by the seller to the buyer – after completion if any warranty proves to be untrue the buyer can bring a claim against the seller for losses suffered. In the SPA the seller may also provide the buyer with indemnities (an obligation for the seller to reimburse the buyer if a specified event comes to fruition post-completion. For example, the parties know that the Target is subject to an ongoing litigation case and the seller provides an indemnity to the buyer in the event the Target loses that case post-completion and has to make a pay-out).
- The buyer might discover issues in the Target as part of the due diligence process (or the seller might tell the buyer about them anyway). The seller would also note these in a disclosure letter to the buyer, meaning the buyer can’t bring a claim against the seller about them later.
- The buyer will want to deal with any such issues before completion (for example, by making the seller rectify any issues pre-completion, demanding a price-chip or seeking an indemnity from the seller in the SPA).
- Hopefully the transaction completes (and everyone celebrates!).
What is a W&I deal?
So, what actually is a “W&I deal”? Essentially, it’s a corporate transaction which is underwritten by warranty and indemnity insurance.
The trend began some years ago and the approach has been used in transactions steadily since. The parties will agree whether or not to use a W&I policy at an early stage of the transaction process (usually in the heads of terms). One party will approach their insurance broker to obtain “warranty and indemnity insurance” from an insurance company. Having this policy in place means that if after the deal completes the buyer needs to bring a claim against the seller (for a breach of warranty) or get cash from the seller under an indemnity in the SPA then, to the extent it is covered by the policy, the policyholder will actually approach the insurance company for that money. In the case of a policy taken out by the buyer, there is no recourse to the seller. In the case of a policy taken out by the seller, the seller would claim against the insurance policy in respect of any sums it was liable to pay the buyer.
Although a W&I policy may be taken out by the buyer or the seller as policyholder, in reality in recent years it is mostly the buyer who will take out the policy.
Why do a W&I deal?
A W&I policy is convenient in a few ways:
- It can provide comfort to the buyer, for example if the seller has poor covenant strength and the buyer wants to be able to claim against a party of substance, using a policy to instead get the money from an insurance company is a good alternative.
- A policy might also offer reassurance to the seller, for example if the seller wants to take the transaction proceeds and quickly apply them elsewhere without being concerned about setting funds aside in case the buyer brings a claim years down the line; having a policy in place allows the seller a swift and clean break. In an auction sale in particular, a bidder might gain a competitive edge in the process by offering to use a W&I policy to give the seller that clean break.
Since COVID-19 there has been a general uptake in interest in W&I deals on both the buy and sell-side for these reasons; essentially, as a way of getting deals done quickly (clean break) and with confidence on seller covenant strength.
However, a W&I insurance policy does not provide total protection for the policyholder and it does require additional steps in the deal process. We’ve focused on three main areas below:
- Process – a W&I deal involves a lot more process for the policyholder. They will need to engage their broker early on and discuss in detail what the policy is to cover. The broker will then approach several insurance companies and provide offers to the intended policyholder for review. Once the intended policyholder has decided on a policy, they will need to keep the insurance company up to date on all aspects of the actual deal, including the due diligence, negotiations and transaction documents. The insurance company and its legal counsel will thoroughly check and comment on all of these materials – they want to know that the policyholder has done a very thorough job and won’t provide a policy unless they are confident about this. This process runs alongside, and sometimes intertwines with, the ongoing negotiations with the other deal party. All in all, a lot more work for the policyholder and their advisors to keep the insurance company involved and happy behind the scenes.
- Cost – the policyholder will need to pay broker fees, the insurance policy premium and increased advisor costs (although the buyer and seller may negotiate for the premium at least to be split between them in some way).
- Coverage – as with any insurance policy, the insurance company will only cover low probability events. They won’t cover known issues – that’s for the buyer to negotiate a solution with the seller pre-completion. The areas of coverage will also need to be discussed – while the insurance company may cover issues around general warranty claims, they will want different policies to cover issues that are really fundamental (e.g. title, tax) or specialist (e.g. hazardous waste) and these will have higher premiums. In addition, the actual amount of coverage under any policy will also need to be negotiated; in fact, the policyholder is likely not to need (or want to pay for) 100% coverage on amounts claimed under the SPA, so the policy may only cover a set amount (e.g. 10% of the claim) – it really depends on what the Target does/holds.
Bear W&I in mind
If you are looking to do a somewhat challenging deal – whether you’re dealing with a cash-strapped seller or one looking to move on, or trying to find that edge in a competitive bidding process – W&I insurance could be the pragmatic solution for you.
This note reflects our opinion and views as of 5 October 2021 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.