Warranties & Indemnities insurance policies: advantages and costs
Italian M&A transactions are experiencing a growing interest in Warranties and Indemnities policies (W&I) which represent an efficient and significant tool for protecting against misrepresentations. What are the key features that contribute rendering a W&I policy attractive?
Warranties & Indemnities insurance policies ("W&I") made their first appearance in the 1980s as an alternative warranty tool in the M&A transactions for covering risks of breach of the Representations and Warranties rendered under the sale purchase agreement ("SPA").
W&I policies are largely used in Europe with a significant and consistent increase also on the Italian insurance market (albeit at a lower level than other European jurisdictions) evidencing a growing amount of deals carrying such insurance policy.
W&I policies can be essentially divided into buyer and seller-side policies, depending on the relevant beneficiary.
The key features that contribute to rendering a W&I policy attractive for both parties involved in a M&A transaction are: (i) the possibility of obtaining the financial means to deal with the breach of R&W; (ii) the avoidance of disputes between the parties for the recovery of sums due as a result of a breach of R&W; (iii) the shifting of risk to the insurer; (iv) the one-off premium payment against a warranty that may last for years (generally up to seven); (v) a tailor-made structure as close as possible to the warranties set forth in the SPA.
With particular reference to buyer perspective, the benefits of subscribing a W&I policy include: (i) the possibility to negotiate a lower price for the purchase of the target; (ii) an increase in investment protection in the event that the indemnity granted by the seller in the SPA is unsatisfactory, for example when the seller is not willing to bear the risk of a higher indemnification being in a stronger bargaining position; (iii) greater protection whenever the solvency of the seller is uncertain; (iv) an advantage in case of competitive auctions between several bidders; (v) effective coverage also against fraudulent conduct by the seller; (vi) a supplemental warranty tool in addition and above the seller's indemnity clause cap pursuant to the SPA; (vii) the possibility of maintaining good relations with the seller in the case of a non-totalitarian acquisition of the target; (viii) simplification of the process for obtaining compensation in case of multiple sellers. Moreover, in the buyer-side policy, the buyer can directly file a claim against the insurer which has to "step into seller's shoes" and indemnify the buyer, operating the policy on a first demand basis, without the condition of the prior enforcement of the indemnity provisions against the seller.
From a seller-side perspective, having a W&I policy would allow: (i) negotiating a higher selling price in light of the additional warranty provided to the buyer; (ii) immediate access to the full consideration for the sale of the target, avoiding other typical alternative warranty tools such as escrow accounts (that eventually result in the impossibility to have the sums "trapped" as warranty immediately available), or the use of expensive bank sureties that are often difficult to find; (iii) to obtain the exclusion of the insurer's recourse against the insured, except in the case of fraud. The protection against the insurer's right of recourse is probably the most attractive feature of the seller-side W&I policy, especially if compared with other warranty tools, such as sureties where the guarantor always has the right of recourse against the individual whose obligation is guaranteed.
Typically, a W&I policy does not cover facts known to the insured, as, for instance, those findings detected during the due diligence process or negotiations (even if the insurer, upon payment of a supplement over the premium, could accept to insure known risks which are contingent), forward looking events, fines and penalties against the insured and not insurable by law and post-closing price adjustments.
With specific reference to fraud, it should be noted that Article 1900 of the Italian Civil Code expressly provides that "the insurer is not obliged for accidents caused by fraud or gross negligence of the policyholder, the insured or the beneficiary, unless otherwise agreed in cases of gross negligence". The underlying reason is that, should the insurance extend to fraud of the insured, the latter would have a positive interest in the occurrence of claim and no insurer would be willing to bear such a risk.
Market standard buyer-side W&I policies always insure full coverage against seller's fraud, allowing the buyer to be covered from fraudulent conduct of the other party.
On the other hand, market standard seller-side W&I policies always exclude protection against the seller's own fraud on the basis of the principle described above.
Seller-side policies do not also cover from fraud not directly attributable to the insured party; that is the case of "passive sellers", i.e. sellers not actually involved in the day-to-day management of the target, when the R&Ws pertaining to target are basically rendered and relied upon the information provided by directors, employees and other officers involved in the management of target.
The cost of a W&I policy is strictly linked to the complexity of the transaction, the duration of the coverage, the quality of the due diligence process and, more in general, the insured's attitude towards risk: as the envisaged coverage increases, so does the premium.
The premium may generally range among 1 and 2% of the insurance limit but can be higher or lower depending of deal and insurance policies specific features, also depending on the amount of the fixed excess, and is normally due in full at the date of policy inception.
However, most of insurance companies usually provide for a minimum premium "floor" price around 70,000 euros.
For such reasons W&I policies better suit larger deals rather than smaller ones in which the handling and allocation of risks can make the difference between a successful transaction and an aborted one.