Warranty and Indemnity Insurance - Part II

In this, Part II of our two-part blog post on warranty and indemnity insurance, we look at the insurance policy itself, provide an overview of the process required to obtain cover, the costs associated with it, the mechanics of a policy, and the claims process.

Warranty and Indemnity Insurance - Part II

W&I insurance policy overview 

W&I insurance policies are usually negotiated prior to the signature of the acquisition agreement. In some instances this will be after signing but prior to closing of the transaction and in very few cases, after closing. A buyer and a seller will first discuss with a broker or an insurer whether the representations and warranties contained in the acquisition agreement are insurable. The negotiation of the W&I insurance policy terms is intricately linked to the insurer's due diligence findings and the terms of the acquisition agreement. The most important matters discussed during the negotiation of the policy will be: 

  • the scope of the losses insured;
  • the exclusions;
  • the impact of any knowledge qualifiers; 
  • the terms of coverage; 
  • dispute resolution and subrogation provisions; and, 
  • to the extent required by the insurance, closing bring down certificates. 

The acquisition agreement will typically make reference to the obtaining of a W&I insurance policy in the covenants section, the list of closing conditions, and/or the remedy/indemnity provisions. The acquisition agreement will also record which party is obliged to purchase the policy and pay the costs in connection with it. 

Mechanics of a W&I insurance policy 

The insured under a W&I policy can be the buyer, the seller or even the target company. It is therefore imperative to ensure that all persons and legal entities that should be covered under a policy are included in the definition of "insured" in the policy document. 

As discussed in Part I of our blog post, W&I insurance will cover loss suffered by the buyer arising from a breach by the seller of the warranties and representations contained in the acquisition agreement. Generally all warranties and representations will be covered, but the policy can also be structured to cover only specific warranties and representations, and might contain certain qualifiers for specific representations. 

With regard to the loss suffered by the insured, the definition of what will constitute "loss" for the purposes of a W&I insurance policy should mirror the extent of the indemnity negotiated and agreed to by the parties in the acquisition agreement. The defined terms and coverage recorded in the policy should not conflict with the provisions of the acquisition agreement and should adequately cater for the intention of the insured in obtaining insurance. "Losses" can be defined in the policy to also cover defence costs, fees and expenses incurred by the insured in relation to a breach resulting in a claim under the policy. 

Costs associated with a W&I insurance policy

The insurance broker will levy a brokerage fee for its work in obtaining quotes, preparing the non-binding preliminary indication letter and all of the other assistance it provides during the W&I insurance process. This fee will typically be a percentage of either the policy limit or the premium payable. 

As discussed in Part I, the insured party will be required to pay a premium, which typically ranges from 1% to 4% of the cover limit provided under the policy. The premium will normally be paid at the closing of the transaction. However in some instances 10% of the premium is paid at signing (when the cover is put in place) and the remainder is paid at closing. 

The insurer also receives a non-refundable underwriting fee, in most cases, paid to it before it starts the underwriting process. The underwriting fee may or may not be inclusive of the due diligence fee which the insurer may also levy. The due diligence fee provides cover for the costs incurred by the insurer in conducting its due diligence in relation to the transaction. It is more likely that the due diligence fee will be included in the premium to be paid if the insurance contract is concluded. 

Who pays the brokers fees, premium, underwriting fee and any other costs which may arise in connection with W&I insurance is usually something negotiated by the parties to the transaction, and they may be borne by either the buyer or the seller, or split between the parties. 

Claims process 

In the case of a buy-side policy, the buyer (as the insured) will file a proof of loss claim directly with the insurer. In this circumstance, the insurer "steps into the shoes" of the seller and indemnifies the buyer directly for the losses insured. The effect of the buy-side policy is to indemnify the buyer for the insured losses. 

In the case of a sell-side policy, the seller (as the insured) files a proof of loss claim with its insurer for breach of warranties and/or representations which the buyer has notified to it. The seller will then either be reimbursed by the insurer for any payments which it has made to the buyer in relation to the breach(es), or the insurer will pay the relevant amounts directly to the buyer. The effect of the sell-side policy is to make the seller whole after paying the insured claims under the acquisition agreement.  

Claims brought under W&I insurance policies typically relate to losses resulting from a breach of warranties or a failure of representations relating to financial statements, compliance with laws, taxes and undisclosed liabilities. 

Many W&I insurance providers now have dedicated claims professionals and long-established relationships with premier law firms and experts to offer high quality claims solutions, thus making the claims process relatively simple and streamlined. As a result, W&I insurance is gaining more attention and is seen as a key part of many transactions across the globe. If you missed Part I of our two-part blog post on warranty and indemnity insurance, please click here.

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