W&I Insurance Update

PUBLISHED: 23rd May 2023

Warranty and indemnity insurance has been used for many years in corporate transactions to provide a buyer with recourse under an insurance policy if there is a breach of a warranty or if an indemnity claim arises.

Benefits and exclusions

One of the most attractive benefits for sellers is the reduction in exposure to the risk of a claim against them personally.  In addition, W&I Insurance often enables immediate access to all of the proceeds of the sale, as there is less of a requirement to leave funds in escrow should a claim arise.

For buyers, perhaps the most notable benefits are having recourse to an entity with financial substance, i.e., the insurer; and avoiding the need to make any claims (and potentially commence litigation) against the sellers.

Indeed, W&I Insurance can be a neat solution to some tricky situations such as:

1. A seller being unwilling (or unable as a matter of policy) to provide general warranties and/or indemnities (such as private equity and institutional investors).
2. If the parties are unable to agree on the sellers’ liability cap.
3. Where certain sellers stay on as employees of the target often in managerial roles, and the buyer will not wish to bring a claim against one of its own employees.

Insurers providing W&I Insurance will apply market standard exclusions in the W&I Insurance policy.  For example, coverage may exclude certain warranties that:

1. are forward-looking;
2. address compliance with environmental legislation;
3. speak to the condition and title to real estate assets;
4. deal with medical or professional negligence; or
5. confirm no criminal fines and penalties have been incurred.

As certain trends continue to emerge and develop around the use of W&I Insurance in Irish corporate transactions, it is worth having a look at developments in the W&I Insurance market in the UK, and any related impacts on the structures of corporate transactions.  

The £1 cap

One notable development is the use of nil recourse structures in private equity backed transactions.  In a nil recourse structure, the liability of the sellers for warranty claims is capped at £1.  As the excess under the W&I Insurance is unaffected in that structure, the W&I Insurance excess amount becomes the de minimis threshold for claims.  Buyers effectively assume the risk of claims for an amount less than the excess under the policy.

The buyer's perspective

The circumstances of certain transactions may lead buyers to adopt a more commercial and pragmatic approach in relation to the sellers’ interests.  As noted above, there are a few tricky situations where W&I Insurance can assist to progress negotiations.

The reductions in the average excess under W&I Insurance policies (as a percentage of the transaction value), which have been seen in the last few years in the UK, have also resulted in the gradual reduction of the level of cover provided by the sellers.  Buyers in large transactions are unlikely to bring a claim against the sellers for amounts less than the excess.  These factors have contributed to an increasingly positive perception by both buyers and insurers to nil recourse structures.

Nil recourse structures can encounter some resistance from buyers in transactions involving targets that operate in industries where the risk of warranty breaches for amounts, which are less than the excess under the W&I Insurance policy, is greater than what may be considered prudent for the buyer to assume.

The sellers’ perspective

Nil recourse structures are clearly very advantageous to sellers.  But it is important to advise sellers that having obtained the buyers’ agreement to such a structure does not mean that the sellers may be remiss in their approach to disclosure against the warranties.  Indeed, the opposite is the case for the following reasons.

1. Insurers insist on being provided with evidence that a thorough disclosure exercise has been carried out before they will agree to provide cover.
2. A reckless or negligent approach to the disclosure exercise may result in the sellers stepping into the realm of fraud, negligent misrepresentation or misconduct.

In such scenarios, it is possible that neither the W&I Insurance nor any limitations on liability provided for in the sale agreement will apply.  This can leave the sellers unprotected against any claim for breach of warranty.

Environmental liability coverage

Environmental liability insurance (also known as pollution legal liability (PLL) or environmental impairment liability (EIL) insurance), is a relatively new product that is becoming increasingly popular in the UK.  That may be attributable to increasing regulatory compliance requirements and movements towards sustainability and engaging with ESG targets. 

Whereas W&I Insurance typically excludes environmental matters, the scope of environmental liability insurance will cover liability for pollution if it was caused before the insurance was taken out (including under previous site owners).  Remediation and third-party claims can also be covered.

Recommendation

We recommend that parties consider whether W&I Insurance or environmental liability insurance is necessary or desirable at an early stage of a corporate transaction.  If the parties decide to avail of such insurance, the insurers and their advisers should be engaged as soon as possible.  Any issues that the insurers may raise should be addressed in order to understand the extent of what cover may be obtained and so that the acquisition documents can be tailored accordingly.

Jennifer McGuire and James Byrne.