The Warranty & indemnity (W&I) insurance policy, an already well-known and popular product overseas and in the western M&A markets, is now gaining a presence in Hungary and is being used more and more in high value deals.
W&I insurance policies provide cover for breaches of representation, warranties and indemnities, including tax indemnities (i.e. tax covenants) made by the seller in a share or business asset sale and purchase agreement. There are essentially two types of policies:
- the sell-side policy: providing coverage for the seller for losses arising from its own breach, and are essentially the claims of the buyer.
- the buy-side policy: covering the buyer against the seller’s misrepresentations or warranty and indemnity breaches. The buyer may turn directly to the insurer without having to assert a claim against the seller. A buy-side policy is more commonly used in M&A transactions.
Why would it be worth taking out a W&I insurance policy?
Apart from the general benefit of reducing risks, acquiring W&I insurance may be advisable from the outset of a transaction where the seller wants a clean exit from the deal and to avoid or reduce its contingent liabilities. A W&I policy is also an asset when a seller wants to use or distribute sale proceeds and avoid parking a considerable portion of it on an escrow account as security for a buyer’s claims. For these reasons, such a policy can be popular among private equity sellers.
From the buyer’s perspective the policy may provide a palatable solution where individual private sellers become managers or employees of the target company following its closing. This makes the preservation of a good relationship between the parties of paramount importance, particularly if there are concerns regarding the financial stability and ability of the seller to settle future buyer claims. These policies can also serve as a strategic tool if the buyer participates in an auction process and wants to distinguish its bid from others.
A W&I insurance policy operates in the following ways:
Retention a.k.a. “attachment point” or “excess”: This is the uninsured amount of loss, which will need to be borne by the insured. A W&I policy will typically attach at a level of 1% of the transaction value. This level is usually described as the “excess” or “attachment point” in the W&I policy. The excess may be lower or higher depending on the specifics of the deal.
Limits and exclusions: The W&I policy will also include an insurance limit, which caps the liability of the insurer towards the seller or the buyer. It may also contain certain typical exclusions setting out the circumstances under which the insurer is not liable, such as all matters contained in the disclosure letter or the due diligence reports (i.e. information and circumstances actually known by the buyer), corruption and bribery, fraud (i.e. in the case of a sell-side policy), pension underfunding and transaction specific matters identified by the insurer.
Period of the policy: The policy period usually matches the warranty and indemnity periods determined in the sale and purchase agreement. In the case of a buy-side policy, however, it is common that the policy extends beyond these periods, providing additional comfort to the buyer.
Insurers’ requirements: It is critical for insurers to see that the transaction documents and in particular the warranties are properly negotiated and that the usual processes (e.g. vendor due diligence, thorough buyer due diligence, appropriate enquiries and disclosures by the warrantors, etc.) are followed as if insurance were not being used. Furthermore, it is to be expected that the insurer’s internal M&A team or outside legal counsels will review, comment on and may require amendments to the sale and purchase agreement.
Apart from the premium that is payable as a one-off amount, the parties should not forget about the retention amount and additional costs that may arise for the legal fees the insurer incurred when assessing the risks of the transaction and the review of the transaction documents. In certain jurisdictions, such as the UK, an insurance premium or other related taxes may also apply.
For more information on W&I insurance policies, contact your regular CMS advisor or local CMS experts: Anikó Kircsi and Szilvia Kabacs.