I. What is a W&I insurance?

A W&I insurance offers an insurance cover for warranty claims due to breach of guarantees or due to the right of indemnity arising from a company acquisition agreement. Both the seller and the buyer can be the policyholder. In practice, this role is predominantly taken over by the buyer (buy-side W&I insurance).

1. Sell-side W&I insurance (sell-side police)

In a sell-side W&I insurance the buyer asserts his claims arising from a company acquisition agreement with the seller “in a normal manner”. The seller remains directly responsible towards the buyer. The seller can then have recourse from his W&I insurance within the limits of the insurance cover. The insurance policy usually also stipulates that the insurance company takes over the defense and any possible costs for the settlement of the claims asserted by the buyer.

2. Buy-side W&I insurance (buy-side police)

In a buy-side W&I insurance the buyer asserts his claims up to a predetermined maximum liability amount (“cap“) with the seller and if the amount exceeds the cap, directly with the insurance company. The seller is hardly or not at all involved in the claims settlement process with the insurance company. A recourse by the insurance company towards the seller does only arise if the damage is based on fraud or the intent to deceive by the seller.

II. Which insurance cover can be obtained?

In practice, it has most recently been possible to observe coverage amounts in the range of 10 percent to 50 percent of the enterprise value (“limit of liability”). The insurance cover takes only effect after reaching a deductible threshold, the so-called attachment point. This amount frequently ranges between 0.5 to 1.0 percent of the enterprise value. This is a one-time total deductible which applies to all claims asserted under the police – and not for each claim separately.
If a seller requests a “clean exit“, the attachment point is often identical with the maximum liability amount (cap) stipulated in the company acquisition agreement which concurrently corresponds to the deductible stipulated in the company acquisition agreement.  In addition, insurance companies offer constructions which are equivalent to a mixture of deductible and threshold: For an offer quoting „1 percent of enterprise value tipping to 0.25 percent of enterprise value“ initially the total asserted claims have to exceed the 1-percent-threshold – while all amounts above 0.25 percent of the enterprise value are then subsequently refunded.
Just as in the company acquisition agreement itself, there is a de minimis threshold towards the insurance company. It usually ranges between 0.05 to 0.1 percent of the enterprise value and according to a constant provision by the insurance company, it has to comply with the materiality threshold which was applied within the scope of the due diligence process.
It should be noted that many insurance companies exclude numerous risks from the insurance cover. The aspects excluded typically include:

• Known circumstances or risks which were detected by the buyer within the due diligence or were otherwise disclosed by the seller;
• Areas which were utterly unexamined within the due diligence;
• Forward-looking guarantees;
• Certain tax issues, such as transfer prices und secondary tax liabilities;
• Certain areas of environmental guarantees (e.g. asbestos);
• Product liability or callback guarantees;
• Guarantees in connection with anti-bribery or anti-corruption laws;
• Criminal penalty payments or fines to which an insurance is not permitted by law.

In general, guarantee sections are only covered by the insurance if an adequate due diligence was carried out from the insurance company’s point of view. For this purpose, all due diligence reports have to be forwarded to the insurance company. Within the scope of an underwriting call which will usually be conducted after having received questions in advance in writing, any open issues and (supposed) deficiencies or gaps of the due diligence are discussed and, as far as possible, enlightened.
If guarantees are considered as given as of closing as well, most insurance companies demand a bring-down-mechanism.
With regard to the concept of damage, the insurance police follows the company acquisition agreement. However, consequential damages and lost profit can sometimes only be insured by paying an additional premium.
With regard to the concept of knowledge, insurance police again follows the definition in the company acquisition agreement. Nevertheless, some insurance companies restrict the concept of knowledge in relation between the policyholder and the insurer to positive/actual knowledge.

III. What impact does a W&I insurance have on due diligence and the SPA?

A W&I insurance is not a replacement for a careful and comprehensive due diligence. Quite the contrary: insurance companies expect a profound due diligence and offer insurance cover only in those sections which have been adequately covered by the due diligence.
After all, a W&I insurance is not a “free pass” for SPA negotiations. It might seem at first as if the seller could be particularly lenient during a “clean exit” concept when it comes to concessions with regard to the guarantees. Insurance companies, however, place great value on the company acquisition agreement in such way that it is negotiated seriously and at arm’s length as if there was no W&I insurance involved in the concerned company purchase.
It is advisable to continuously align the markups made within the SPA negotiations with the insurance company which at this stage is already included in order to continuously ensure the insurability of probably extended guarantees and indemnities. Whether and to what extent an insurance cover can be granted, will usually be outlined within the scope of a so-called warranty spreadsheet. If an insurance cover is refused due to a due diligence which was supposedly not profound enough by that time, almost all insurance companies offer the possibility to “improve” the due diligence effort if the policyholder places value on such cover.
It is strongly recommended to align the continuously update scope of insurance cover with the company acquisition agreement in order to avoid undesired cover gaps.

IV. How long is the policy period?

The term of the policy depends on the type of the affected guarantee or indemnity. Typical terms of “fundamental guarantees” (esp. legal title) are often 7 to 10 years, of regular guarantees 2 to 3 years, for tax guarantees 2 to 3 years and for tax indemnification approx. 7 years. An extension of the respective term is possible with almost every insurance company by paying an increased premium. However, it is sometimes possible to achieve an extension even without paying an additional premium.

V. How much does a W&I policy cost?

The premium amount depends on many factors, especially on the amount of the deductible and the policy term, and usually amounts to between 0.8 to 1.5 percent of the sum insured (“rate on line”). In Germany, an insurance tax payable of currently 19 percent is added to the premium. The premium payable is a one-off expense. Finally, it should be pointed out that many insurance companies earmark a minimum premium which in many cases amounts to EUR 50,000 to EUR 100,000. Against this background, a W&I insurance only pays off in cases of M&A transactions with an accordingly high enterprise value
Many insurance companies charge additional so-called legal fees which are supposed to cover the insurance company’s handling costs for the examination of the due diligence reports etc. These costs usually amount to between EUR 20,000 and EUR 30,000. Sometimes it can be achieved to credit the legal fees to the premium in case of a conclusion of a policy with the insurance company involved.
The premium is always paid by the policyholder, i.e. in case of a sell-side police by the seller and in case of a buy-side police by the buyer. However, as the insurance solution is primarily in the interest of the seller, the buyer will try to economically deduct the premium from the purchase price.

VI. What is the role of a broker?

Buyer and seller do often not approach the insurance companies directly but via an intermediary broker. A broker can help to make a first exploration of the different insurance products and to put that information together in a “non-binding indication report”. If a seller wishes a “clean exit”, it is often the seller who engages a broker already within the preparation of the selling process to gather indicative offers on the basis of the SPA as drafted by the seller and to provide these offers to the buyer(s) in the data room. Any further communication or negotiation with the insurance companies is taken over by the buyer (then again via a broker), so-called flipping.

VII. What are the advantages of a W&I insurance?

W&I insurances can yield several advantages for the buyer and the seller:

• „Bridging the Gap“: In many situations the seller is prepared to give guarantees, however, he demands a cap that is way too low from the buyer’s point of view. With a W&I insurance it is possible to increase the cap as a whole which is essential to the buyer by the insurance becoming effective as soon as the cap towards the seller is reached (up to the cap stipulated with the insurance company);
• „Clean Exit“ for the seller: In many cases the seller is not even prepared or able to issue guarantees in a company acquisition agreement, e.g. because sale proceeds are to be paid out to the investors straight after the closing of the transaction. W&I insurances can make a “Clean Exit“ possible for the seller while offering security regarding the guarantees and indemnities for the buyer. For this purpose, the cap towards the seller is set at EUR 1.00 or the cap towards the seller corresponds to the deductible agreed;
• Solvent opponent: If the opponent can in fact pay the amount claimed in case of a breach of guarantees or a right of indemnity, can sometimes be unclear to the buyer. This applies especially in such constellations where the seller acts as a “Special Purpose Vehicle (SPV) or if he is in financial difficulties. With a renowned insurance company that is established on the market, the buyer can generally expect financial solvency and ability to pay. Therefore, the buyer’s need for security mechanism against the seller is unnecessary (e.g. in the form of an escrow);
• During a bidding process, the buyer’s offer to use a W&I insurance and to reduce the seller’s liability de facto to zero can be a strategic advantage in order to set himself favorably apart from further bidders with identical bidding conditions apart from that.

VIII. What are the disadvantages of a W&I insurance?

The following disadvantages of a W&I insurance are to be particularly pointed out:

• In contrast to bilateral negotiations with the seller, the buyer has to negotiate with both the seller and the insurance company, which means an additional effort;
• Due to the „Standard Policy Exclusions“ numerous guarantee sections are often not covered by the insurance police. If the seller can enforce a “Clean Exit” (deductible = cap), the buyer has no security in this respect, as all exemptions in the insurance cover fully impact the buyer’s warranty protection (which no longer exists);
• Even though the premiums most recently significantly decreased due to the pricing pressure in the market on W&I insurances, a W&I insurance is not a bargain: below 1 percent of the insured amount (“Rate on Line“) is an exception rather than the rule. Owing to the demand for a minimum premium, a W&I insurance only pays off for company sales above a certain size as regards the enterprise value;
• Due to the inclusion of the insurance company in the negotiation of the company acquisition agreement to be negotiated between the seller and the buyer, the process can slightly slow down. However, nowadays insurance companies are very professionally prepared and react promptly (especially in case of a corresponding process planning).

IX. Conclusion

There is a clear trend towards W&I insurances. Having said that, it is indispensable for the parties to larger company sales in M&A transactions to familiarize with the fundamental operating principle of this “tool”. However, only those sellers and buyer who have an experienced consultant at their side who is proficient in all the details and intricacies of W&I insurances will sufficiently profit from this instrument.