Warranty & Indemnity Insurance: an increasingly popular insurance (Stibbe)
Author: Matthias Maselis (Stibbe)
Publication date: 12/11/2019
A warranty & indemnity (W&I) insurance covers damage resulting from breaches of warranties given in the SPA by the seller. W&I insurance has been around for many years, but it has become increasingly popular in the last few years. According to Lockton, “recent statistics suggest that over 50% of corporate real estate transactions in Europe now use W&I insurance, a large driver for this has been the adoption of a EUR 1 cap on sellers’ liability under the SPA.”
The seller has a clean exit at a fixed cost. The purchaser, in turn, is not faced with the potential risk of the seller’s insolvency (hence, avoiding the need for retentions or escrows). It also offers a solution, among others, in case (i) the seller is unable to give typical seller’s warranties, (ii) a significant monetary cap under the SPA must be bridged or (iii) the enforcement of a claim would prove to be challenging (e.g., involving multiple private sellers, distressed sale, foreign jurisdictions, etc.).
Sell-side or buy-side
W&I insurance policies can be taken out by the seller (sell-side policy) or the purchaser (buy-side policy). Under a sell-side policy, the purchaser brings claims against the seller. Subsequently, the seller will bring the claims against the insurer (under third-party liability coverage). Under a buy-side policy, the purchaser brings claims against the insurer directly (under indemnity insurance coverage), which is what we most often see in practice. In case of a buy-side policy, all the possibilities of recourse that the insurer has against the seller should be stipulated and addressed carefully.
The process for taking out a W&I insurance is usually managed by an insurance broker and takes about 2 to 3 weeks. In urgent cases, this timeframe can be reduced to 7 business days. After the party (seller or purchaser) submits the main transaction documents to the insurer(s) (i.e., the SPA, investment memorandum and financial statements), the insurer(s) will review them and will usually submit an indicative non-binding offer.
Once the party selects an insurance company after having received different offers, the insurance company will require access to all third-party due diligence findings and to the data room and will verify the documents (usually assisted by external counsel). This is commonly known as the underwriting process. The insurer and his counsel will seek additional information (usually through a written questionnaire) followed by an underwriting call to the party, which typically takes 1-2 hours (although many insurers are comfortable with receiving answers in writing). The purpose here is to provide sufficient comfort to the insurer regarding the transaction, the due diligence issues, and underwriting process. Subsequently, the insurer and the insured, who are assisted by the broker, will negotiate the terms and conditions of the policy. The policy will include a spreadsheet on the coverage details, which describes the specific SPA warranties covered and the extent of the coverage. In addition, the insured will have to sign a no-claims declaration when the policy is signed. As from the signing date (or the policy’s start date), the insurer will confirm that it is “on-risk” of any claims.
Draft with care
One should be careful when negotiating the terms and exclusions of a W&I insurance. A W&I insurance should mirror the terms of the SPA as much as possible, but insurers will often try to negotiate other terms and exclusions than those agreed in the SPA, which can create discrepancies between what is covered under the SPA and under the insurance policy. Terms that are not aligned can lead to recoverability issues. Typical examples of these are different governing laws, different definitions for the term loss, different knowledge-seeking or third-party procedures, different exclusions (cf. below), etc.
Insurance contracts will exclude certain risks from the coverage. Examples include known issues (which make it complicated to obtain coverage for specific indemnities), certain environmental risks, issues that arise between signing and closing and that are known to the purchaser, financial warranties on leakage, pension underfunding, certain tax risks (such as transfer pricing), fraud, criminal fines, condition of the property, etc. If insurance companies are unwilling to cover a certain risk, a specialised insurance might still be available to cover such risk.
Insurers will usually consider the scope of the due diligence (and limitations) when defining the insurance coverage. Areas that were not subject to due diligence will usually be carved out from the insurance coverage. To define what is covered, insurers will expect a negotiated and balanced SPA. Any indications of inadequate due diligence investigation or clear imbalance of the SPA will lead the insurance company to set restrictions on coverage.
Most W&I insurance policies contain a deductible (or retention), which is a fixed amount of loss that the insured party must bear before the policy kicks in. The policy will only cover the excess of the retention (unless agreed otherwise). For operational businesses, this is typically 0.5% to 1% of the enterprise value. For real estate transactions, in which there is a dormant corporate vehicle holding the asset(s) without employees or trading activities, insurers will usually not require a retention and will rely only on the de minimis under the policy instead. Time limitations can be aligned with the terms of the SPA, but these can also top-up the claims periods under the SPA if the seller has successfully pushed for a shorter period than commercially acceptable. The term for tax and fundamental warranties is in most cases capped at 7 years, the term for general warranties is usually capped at 3 years.
Knowledge of the parties
Insurers will request that some warranties be qualified according to the seller’s knowledge, limiting the scope of their coverage. Insurers do not cover facts or circumstances that were known by the purchaser prior to the parties’ entering into the transaction. In other words, the purchaser will not be able to claim based on facts that were disclosed by the seller to the purchaser or that were revealed during the purchaser’s due diligence (as is typically the case under the SPA).
The cost of W&I insurance varies between 0.7% and 1.3% of the risk insured for a real estate transaction, plus taxes. Depending on the insurer, premiums start as from EUR 35,000.