1. What is M&A insurance?
Transactional Risk Insurance (or simply M&A Insurance) is an umbrella term which encompasses:
- Warranty and Indemnity (“W&I”) Insurance;
- Tax Liability Insurance; and
- Contingent Legal Risk Insurance.
1.1 What is W&I Insurance?
W&I Insurance (also referred to as Representation & Warranties Insurance R&W in the US) is a specialist insurance product covering breaches of representations and warranties and claims under indemnification provisions (including the tax indemnity/covenant), contained in sale and purchase agreements (SPA). It also covers loss or liability arising from unknown or undisclosed matters and liabilities.
1.2 What is Tax Liability Insurance?
Tax liability insurance transfers a known or uncertain tax liability from the insured’s balance sheet to an insurer. The insurer will indemnify the insured for financial loss arising from a challenge from a tax authority. It is an insurance solution which is available both before or after an M&A transaction (or on standalone basis, for example as part of a pre-IPO restructuring).
1.3 What is Contingent Legal Risk Insurance?
Contingent Legal Risk Insurance covers identified or known contingent legal risks which are typically the subject of a specific indemnity in an M&A transaction. It may also be provided for identified “one-off” issues which are not necessarily related to an acquisition or a disposal. It can be used to facilitate a future deal, transfer risk or mitigate a contingent balance sheet exposure.
2. Focus on W&I Insurance
2.1 How does W&I Insurance work?
W&I insurance is provided to either a buyer or a seller for loss arising out of a breach of a warranty or indemnity provided in an agreement for acquisition of a company or a business. The insurer effectively “steps into the shoes” of the party giving the contractual promises.
Each W&I insurance policy is tailored to meet the specific needs of a transaction. W&I insurance is intended to work in parallel with the negotiations and is designed to support (rather than replace) a robust due diligence process.
A W&I policy is a non-renewable, one–off single premium product with the premium typically paid upon completion of the transaction.
2.2 Who can use W&I Insurance?
W&I insurance can be purchased by either a buyer or a seller, although the vast majority of W&I insurance policies are purchased by the buyer.
The need for W&I insurance typically arises when either the amount or quality of recourse that the seller is prepared, or able, to offer is insufficient to the buyer. It is commonly used as a transactional tool by private equity sellers to secure a clean exit, preserving the investor rate of return by avoiding the need for any sale proceeds to be deferred, retained or otherwise held in escrow.
A mismatch in expectations regarding contractual liability can be a barrier to a transaction proceeding. W&I insurance can provide a solution that satisfies both parties’ expectations and bridges the gap.
2.3 Why is buy-side W&I Insurance purchased?
A buyer may wish to use W&I insurance for a variety of reasons. These may include (without limitation):
- enhancing or distinguishing an auction bid;
- increasing or extending the breadth, scope and duration of warranty package offer by a seller;
- protecting relationships with seller(s) or warrantor(s) (particularly where management remains);
- alleviating concerns where uncertainty of recourse or the selling entity is to be wound up;
- providing protection for proceeds of sale;
- to be used as a risk management tool when investing in unfamiliar industries or territories;
- giving extra comfort to lenders (including the ability to assign policy proceeds) or reassure shareholders and other investors;
- mitigating enforcement difficulties where the seller and buyer are in different jurisdictions;
- removing an intractable issue from a negotiation.
2.4 “Stapling” W&I Insurance
Buyer-side W&I insurance policies are often initiated by a seller who either proposes or insists that the buyer enters into the policy as the insured, typically as part of a competitive auction process. This process is often referred to as “stapling” W&I insurance to the transaction.
2.5 “End of Fund Life” Insurance
Alternatively, an “End of Fund Life” policy is a sell-side W&I insurance policy which insures residual liabilities arising from the fund’s investment activities, enabling the fund to close and distribute final proceeds to investors. It enables the fund to ring-fence the risks associated with the sale. It also avoids the need to claw-back proceeds to satisfy indemnification claims.
The use of an End of Fund Life policy is a strategic tool for fund managers to maximise return, ensuring cleaner exits, reducing fund administration costs and ultimately allowing a more efficient final distribution.
3. Complementary insurance solutions in M&A context
A standard buy-side W&I insurance policy is designed to cover only unknown issues in areas which have been the subject of due diligence. Alternative cover may sometimes be available in respect of identified issues. Complementary insurance solutions to consider in an M&A context include:
- Tax Liability Insurance;
- Contingent Legal Risk insurance;
- Defective Title Insurance;
- Environmental Impairment Liability Insurance;
- Cyber Liability Insurance;
- Litigation Buyout Insurance or After The Event Insurance;
- “Run off” D&O insurance.