Transactional Risks
The coverages are designed for both Private Equity firms and strategic buyers as well as for owners and managers considering an exit from a business. The focus is on aiding third party deal advisors, enabling them to execute deals faster and more efficiently. The coverages allow clients to maximise deal valuations, enhance the bid process in competitive auctions and bridge gaps which may otherwise thwart parties from concluding a deal.
A sell-side policy will indemnify the warrantor for any losses suffered as a result of the buyer bringing a valid claim against them for breach of warranty or under the general tax indemnity that requires the seller to make a payment to the buyer. By design, such policies require the seller to retain liability under the transaction documents with respect to warranty breaches and the general tax indemnity.
In addition, the policy will also indemnify the warrantors for the defence and investigation costs incurred. This element of coverage should not be underestimated as these costs can be significant and can, occasionally exceed any settlement or damages for warranty claims.
Ring-fence liability and gain a clean exit without having to tie up sale proceeds.
Where selling shareholders are retiring and want to secure the proceeds:
- Sellers may be unwilling or unable to stand behind the warranties (e.g. in secondary management buyouts or acquisitions from insolvent sellers)
Enhancing a bid in a competitive auction: Bidders can accept minimal caps on liability from a seller and secure higher limits and longer liability periods under the W&I policy.
Key Considerations:
- Policy Limit– Policy limits are typically equal to the seller’s liability for a breach of warranty or claim under the general tax indemnity, but this can be increased to cover gross-up exposure.
- Deductible– Will apply to claims under a W&I policy which will usually reflect the basket disclosed in the transaction documentation, subject to minimum thresholds that are dependant on the nature of the underlying transaction.
- De Minimis– Will apply and will usually be the equivalent to the de minimis in the underlying transaction documentation.
A Buy-Side W&I policy can indemnify a Buyer for losses cause by breaches of warranties given by the Seller in the SPA. Under this type of policy, the Buyer can claim directly from the insurer without first pursuing the Seller. A Buy-side W&I policy will also cover legal defence costs incurred in defending third party insured claims.
Strategic Benefits:
- Potential purchases can present themselves as “deal ready” counterparties that pose a lower execution risk than their rivals.
- To provide the buyer with a strategic advantage in the context of an auction process.
- Protect relationships with sellers who may become the buyers’ employees or commercial business partners after the transaction.
- Provision of debt: Prospective investors and lenders will typically insist on the buyer obtaining warranties so that they have some element of protection if issues subsequently come to light post-competition. If the seller is a fund, they are unlikely or unable to stand behind their warranties. The proceeds of a policy claim can be assigned to the lender(s).
Key Considerations:
- Policy Limit– Typically range from 15% to 30% of the target enterprise value (EV), although a limit of up to 100% can be sought.
- Deductible– Will vary depending on the nature of the underlying transaction and the operational ‘scope’ of the target. Industry sectors that are perceived as ‘higher’ risk may require a higher deductible.
- De Minimis– Will apply and will usually be the equivalent to the de minimis in the underlying transaction documentation. There may be scope for movement, but insurers expect the de minimis to be the same or higher than the materiality thresholds applied to the due diligence reports.
Premium– A ‘one-off’ cost determined by the the policy limit being sought, the nature of the underlying transaction, market sector and governing law of the SPA.
Legal Fees– Each insurer will require a legal fee Expense Agreement to be entered into before beginning the formal underwriting process. This covers the cost of instructing external counsel. These fees invariably range between £10,000-£30,000 although, depending on the nature and complexity of the underlying transaction, they may be higher.
These fees are charged in addition to the premium and are payable upon competition.
Exclusions– there are market-standard exclusions which apply to all W&I policies, including:
- any fact, matter or circumstances of which the seller’s/buyer’s deal team members have actual knowledge.
- fraud of the seller.
- physical condition/design of the properties.
- matters which are ‘Fairly Disclosed’ in the transaction documents, data room and due diligence reports.
- secondary tax liabilities, transfer pricing and the non-availability of carried forward tax reliefs.
Where known issues (e.g. potential tax liability) have been identified in due diligence, it may be possible to obtain specific insurance to cover these exposures.