While Warranties and Indemnities Insurance (“W&I Insurance”) has long since been anchored in Anglo-American transactional practice, this type of insurance has only recently gained importance in continental Europe and, in particular, on the Austrian market.
W&I Insurance is often solely associated with corporate M&A transactions. However, this type of transactional insurance may also prove to be a valuable asset in other kinds of contractual constellations such as real estate transactions. Concisely, the idea of W&I Insurance is to provide an option for closing possible gaps between seller and purchaser as regards the risk allocation in a particular transaction.
During contract negotiation, parties will frequently have difficulties agreeing on the exact wording and scope of their respective contractual commitments as regards the allocation of risk. This is due to the conflicting interests of the contracting parties. The seller, for instance, is usually keen on passing on as many risks associated with the purchase object as possible. By contrast, the purchaser will want to safeguard the seller’s liability for any acts and omissions or misrepresentations regarding the purchase object attributable to the seller. The typical information disparity between the purchaser and the seller adds to the problem. While the former usually has very limited knowledge of the purchase object’s specifications and characteristics, the seller is usually, albeit not necessarily, much better informed.
Risk allocation is usually regulated and governed by the contractual provisions as regards both representations and warranties as well as indemnities. Whereas the representations and warranties are concerned with describing the purchase object and defining what is and what is not to be considered a defect of said object, the indemnities stipulate an allocation of certain liabilities that are considered to be likely or possible to occur in the future but hard to quantify economically. By contrast, risks known to both parties and more easily quantifiable are usually less conflictual and dealt with by way of adjusting the purchase price.
The more complex and economically sensitive a particular transaction is perceived to be, the more likely it is that the parties will – at least initially – disagree on the wording of these risk allocation sections. This may even lead to jeopardizing the entire transaction. Such impasse may be overcome in various ways. One option is the taking out of W&I Insurance.
Types and Scope of W&I Insurance
W&I Insurance products are available both for the seller as well as for the purchaser. As with most related types of insurance, policyholder and insurer will often agree on individualized policy terms, whereas the process of taking out the insurance is broadly standardised. There are, however, some basic differences between “seller-side” and “buyer-side” products, especially as regards their scope of coverage.
Seller-side policies have their primary focus on situations where the purchaser asserts a claim vis-à-vis the seller arising from an alleged infringement of representations, warranties or indemnities. Insurance coverage usually requires a final court decision and is limited to the maximum liability stipulated in the underlying contract (e.g. Share and Purchase Agreement). In this regard, the typical seller-side policy constitutes a form of pecuniary loss liability insurance (Vermögensschaden-Haftpflichtversicherung).
Buyer-side policies, on the other hand, typically protect from losses suffered by the purchaser or the target company due to infringements by the seller. As opposed to the seller-side model, the purchaser may assert its claim directly against the insurer without having to lodge a claim against the seller first, which makes this insurance product a form of first party insurance (Vermögensschaden–Eigenversicherung).
However, not all W&I Insurance products are purely focussed on either the seller’s or the purchaser’s interests. For example the so called „seller buyer flip” or “stapled W&I” model is a product where the seller obtains a noncommittal insurance quote regarding a planned transaction early on in the sales process. This quote is then offered to potential purchasers along with the sales offer and contract draft. The insurance policy is then finalized between insurer and purchaser and taken out by the latter.
W&I Insurance policies are oftentimes designed as a “back-to-back” coverage. This means that the warranties and indemnities included in the underlying contract are seamlessly integrated and reflected in the W&I Insurance policy. While such “back-to-back” coverage can be advantageous, this structure is not mandatory.
Uninsurable risks or risks usually not covered are, inter alia, fines and monetary penalties, purchase price adjustments, product liability claims and fraud or fraudulent misrepresentations by the policyholder (including situations where both contracting parties collude against the insurer’s interests). Most W&I Insurance products, by default, exclude known risks and disclosed circumstances from coverage. Where the policyholder desires coverage for such risks, insurers will sometimes – after having assessed such risks in more details – offer coverage for an increased insurance premium.
Areas of Application and Reasons for Taking out W&I Insurance
As already laid out, W&I Insurance cover is often taken out in order to overcome impasses during the negotiation process as regards risk allocation. Another reason for taking out this type of insurance may be the seller’s inability to provide warranties and indemnities of adequate commercial value, e.g. where the target originates from assets in the insolvency.
Also, W&I Insurance premiums are, in many cases, lower than the costs associated with providing other securities such as escrow account solutions and allow for the purchase price to be paid in full immediately after closing (“clean exit”). Moreover, some parties chose to add W&I Insurance cover merely to avoid or minimize negative impacts on their respective business relationships.
In other situations, the purchaser’s financing bank may require the purchaser to maintain W&I Insurance coverage. Cross-border transactions are yet another area of application. This is because these constellations often entail legal or factual difficulties as regards the enforcement of possible claims (“jurisdiction enforcement risk”).
Assessment of Risks by the Insurer
Whenever the decision to take out W&I Insurance for a particular transaction is taken, the insurer – at least initially – has no or only very limited knowledge about the transaction. For this reason, the insurer will assess the possible risks associated with the deal (more specifically: the warranties and indemnities) in order issue an insurance quote. This process will often take about one or two weeks, in which specialized staff of the insurer’s underwriting division or external experts first evaluate relevant documents associated with the transaction and then, as a second step, enter into negotiations with the parties as regards necessary fine-tuning of the insurance policy. For this purpose, the insurer is usually granted access to the data room. The documents most likely to be assessed by the insurer will include the draft contract itself, existing due-diligence reports, annual accounts and, where available, fact books.
Attractiveness of W&I Insurance depending on the Transaction Value
As some insurers set the minimum premium at 50,000 to 100,000 euros, W&I Insurance is currently most common for higher-value transactions. The premium amount is due to the insurer’s high initial costs as regards the necessary pre-contractual risk evaluation. Market trends, however, show a continuous decrease in minimum premiums as insurers optimize their evaluation processes.
Considerations for the Parties Involved
The parties will, in most cases, already have legal representation in the early stages of the negotiation process. In case a party wishes to take out W&I Insurance, such party is well advised to obtain legal expertise as regards the transaction’s insurance aspects as well. This is because the actual value and effectiveness of the desired insurance coverage depends largely on the convergence of insurance policy and underlying contract. Thus, the wording of the insurance policy does not only have to take into account any legal particularities and hurdles associated with the transaction itself. It is of equal importance that any changes made to the draft contract in the course of the negotiation process as regards their legal implications are reflected in the final wording of the insurance policy as well.
The process of taking out W&I Insurance will not only take up a certain period of time and require additional coordination with the insurer. Parties should also be aware that insurers will, from time to time, demand changes made to the draft contract before agreeing to provide insurance coverage. Thus, parts of the contract already agreed upon may have to be renegotiated.
From an insurer’s perspective and judging on the experiences made with other insurance products in the past, it seems sensible or even critical to consult local legal experts both before launching new insurance products and, in complex cases, also after insurance claims are lodged. Especially, insurers should refrain from drafting insurance conditions for such products based solely on the wording of conditions designed for a different market or jurisdiction. The differences in substantial and procedural law as well as cultural distinctions generally call for a carefully considered and individual wording.
Finally, a consideration to be taken into account by all parties involved is that W&I Insurance products – although having been around for decades – are only slowly gaining importance and market relevance in continental Europe. As a consequence, the complex reciprocal effects of a specific W&I Insurance product under certain market conditions are not sufficiently established yet and will only transpire over time. Thus – although the insurers are highly professional and have extensive experience from other markets – all parties involved, at least on the Austrian market, are currently part of what might still be called an ”experimental phase“. This fact is not necessarily disadvantageous. All the same, parties should be wary of this and seek individual and independent advice on the (W&I) insurance aspects of a planned transaction.
W&I Insurance may prove to be a valuable tool for overcoming difficulties or uncertainties in contract negotiation. Taking out W&I Insurance can minimize the risks associated with a particular transaction significantly (but not entirely). Although W&I Insurance has become more popular over the last few years, only a minority of the relevant market actors, i.e. sellers and purchasers, is aware of this transactional insurance product and its operating principles. Judging by the rise of other Anglo-American insurance products on the Austrian market (such as D&O Insurance), the Austrian W&I Insurance market is expected to grow considerably in the years to come – especially in the still booming, but considerably tighter real estate market. Owing to the insurers’ efforts to streamline their respective risk evaluation processes and increased competition between insurers on the Austrian market, a further decrease in minimum insurance premiums can be expected. This will further increase the attractiveness of W&I Insurance also for medium and lower-value transactions.