When selling company shares, the seller typically provides certain warranties and indemnities to the buyer. Common warranties include, among others: the existence and unencumbered status of the shares being sold; the accuracy and continuity of the financial statements; ownership and freedom from encumbrances of intellectual property rights; ownership, unencumbered status, and usability of fixed assets; continuity and validity of key contracts; adequate and active insurance coverage; absence of environmental risks; non-existence of legal or administrative disputes; and the possession of required public permits.
This catalogue of warranties is tailored to each transaction and represents a central negotiation topic—particularly regarding the type of warranties, liability caps, liability period, and the securing of claims for damages in the event of a breach. To avoid protracted discussions over warranties, purchase price retentions, escrow accounts, or bank guarantees—which can even become deal-breakers—a streamlined solution exists: W&I insurance (Warranties & Indemnities insurance).
What is W&I Insurance?
W&I insurance covers unknown (and, if desired, known but not quantifiable) risks arising from warranty breaches. It can serve both to protect the buyer (first-party loss cover) and the seller (liability cover), shifting risk from the respective balance sheets of buyer and seller to that of the insurer (or an insurance consortium).
The duration of cover usually mirrors the warranty period agreed in the purchase agreement. The scope of coverage is largely a cost-benefit decision but should be aligned closely with the terms of the contract.
W&I Insurance in the M&A Process
A W&I insurance policy can be initiated by either the seller or the buyer. In both cases, the process generally follows these steps:
- Execution of a confidentiality agreement with a broker
- Provision of transaction information to the broker (e.g., draft SPA)
- Broker approaches insurers
- Broker presents an overview of available offers
- Selection of insurer
- Insurer conducts non-intrusive due diligence (e.g., review of buyer’s DD reports)
- Insurer issues a binding offer
- Policy execution (typically 2–4 weeks after initiation)
If the seller takes out the insurance, they still remain liable to the buyer under the purchase agreement and can only later recover from the insurer. This has disadvantages, including:
- Claims must first be directed against the seller
- No joint and several liability if multiple sellers exist
- Seller may lack the solvency to cover damages
- Seller may no longer be reachable
- Insurer may reject the claim, leaving the seller exposed
As a result, the so-called “Stapled Insurance” has become more common. In this model, the seller initiates the insurance process and provides bidders with a non-binding offer from insurers. The buyer then finalizes negotiations and becomes the policyholder. This ensures that W&I insurance does not become a bottleneck in the final transaction stages and provides a clean cut between seller and buyer.
Costs
The cost of W&I insurance typically amounts to around 1.5% (+/- 0.5%) of the coverage amount, with most insurers setting a minimum premium of approximately €50,000. The deductible is usually about 1% of the enterprise value.
Insurers expect a minimum level of due diligence. While this can drive up transaction costs, it also means W&I insurance only becomes viable above a certain minimum transaction size. For sector-specific risks outside the standard scope (e.g., unknown environmental liabilities in an oil-processing company), premiums can increase substantially.
W&I Insurance in Light of the COVID-19 Crisis
The immediate consequences of the pandemic for M&A processes include smaller bidder fields, slower ongoing processes, and the postponement of new transactions. While W&I insurance cannot eliminate uncertainty in the current environment, it can provide clarity for the period after completion. By reducing risk, W&I insurance remains a valuable tool for achieving successful transactions.
For further questions about W&I insurance, your i-capital team is happy to assist you. Please feel free to contact us at any time.ie uns!
