Global M&A transactions reached a new all-time high in 2021. However, as a result of the war in Europe and Covid-19 disruptions, inflation and other market risks are increasing – as well as uncertainties in M&A transactions. Learn why an increasing number of companies are preparing for disputes following M&A deals, what advantages warranty & indemnity insurance can offer and what decision-makers should know.
A recent case
Sellers can face significant claims for damages if a financial statement warranty turns out to be false. A recent case in the aviation industry demonstrates how you can protect yourself against such claims. Shortly after signing the sale and purchase agreement (SPA), the buyer of an airline discovered lease agreements for two airplanes were accounted for incorrectly. The management of the airline had assumed that it was reasonably certain to exercise a renewal option on the lease. However, the lease agreement itself did not even contain such an option.
It was pretty obvious: the seller had breached a warranty. However, the buyer of the airline had entered into a warranty and indemnity (W&I) insurance policy, which covered the risk and protected the parties against the consequences. The buyer could claim the damages directly from the policy holder and – after negotiations behind closed doors – achieved a settlement of around EUR 8.5 million.1
W&I insurances in the current market environment
Recent market studies demonstrate a growing popularity of the involvement of W&I insurance in M&A deals last year. This development is not surprising since the global M&A activities in 2021 reached a new all-time high – both in the number of transactions and purchase prices2 – with deal value totaling USD 5.1 trillion.3 Based on our observations, this trend continued at least in the first half of the current year. As prices rise, so does the buyer’s need for protection.
As a consequence, the W&I business recovered rapidly after a drop-off in 2020 during the Covid-19 pandemic. Insurers even reached personnel capacity limits temporarily.4,5 The share of transactions involving such specialty insurance products rose to a record level of 19% in 2021 versus just 10% in 2010.
The bigger the deal, the higher the demand for M&A insurance. In almost half of transactions with a value of more than EUR 100 million, the parties made use of W&I policies.6
In our view, the portion of insured transactions will continue to rise. Despite the war in Ukraine and rising inflation and market risks, purchase prices remain high. In our experience, M&A disputes may become more frequent in the event of an economic downturn. If a downturn occurs between signing and closing, the negotiated price may appear subsequently inflated and a buyer may try to identify opportunities to reduce the purchase price or obtain compensation based on the SPA.
Significant advantages of W&I policies
W&I insurance facilitates the sale and purchase process and provides high strategic value to both sellers and buyers. Sell-side first: by means of an insurance, sellers can limit their liability and transfer the risk relating to breaches of warranties in a SPA to insurance companies, as shown in the case at the beginning of this article. The insurers, not the sellers, are then liable if a representation or warranty turns out to be false.
In this context, the insurance provides a clean exit from the investment. Thus, sellers can determine and distribute sales proceeds much earlier. As a result, W&I policies are an effective tool to close gaps and overcome transaction hurdles between the positions of buyers and sellers: they offer additional leeway in negotiations and can significantly accelerate the closing of transactions.
But buyers also benefit from the insurance coverage, particularly in situations where no solvent debtor is available or the seller is a special purpose entity (SPE). Based on our experience, enforcing claims against such debtors arising from breaches of representations and warranties is difficult if no W&I insurance exists. However, well-known insurance companies may provide sufficient credit ratings. Other protection mechanisms such as escrow accounts which (partly) delay the payout of the purchase price become redundant.
Another advantage of W&I policies is the relatively low premium costs in recent years: today, insurance premiums often amount to approximately one percent or less of the risk to be insured.7 At the same time, the insurable amounts have increased, and the insurance companies have invested in employees with a M&A background. Hence, the further professionalisation of both insurers and brokers enables them to provide tailored insurance solutions under challenging deadlines which offer a customer-oriented service approach.8