In standard M&A transactions, the interests of the parties are rarely aligned. Typically, a buyer demands broad representations and warranties from the seller as part of the definitive documents, while the seller seeks to restrict its exposure post-closing by giving limited and highly qualified warranties to the buyer. One way to bridge this gap is by procuring warranty and indemnity (W&I) insurance.
Although W&I insurance is not expressly approved by the Insurance Regulatory and Development Authority of India (IRDAI), the prevailing legal view is that it is covered under the ambit of commercial liability insurance, which has the approval of the IRDAI.
W&I insurance can be designed to provide cover for obligations to indemnify for losses arising out of a breach of warranties of either the seller or the buyer. A sell-side policy is a contract between the seller and the insurer, under the terms of which a seller can claim reimbursement for defence and investigation costs incurred where the buyer brings a claim for a breach of warranty.
For example, with a sell-side policy, a private equity investor seeking an exit can limit any contingent liability risk arising from outstanding indemnification obligations on the sale of a portfolio company, allowing the fund to disburse proceeds to its investors. Similarly, such a policy can help bridge the gap in the transfer of a business to a strategic investor if the target has been restructured immediately prior to closing, or where the buyer has no control over the excluded assets and liabilities of an undertaking.
In a buyer insurance policy, the buyer is indemnified from loss arising from a breach of warranty by the seller, where the buyer is unable to recover from the seller as a result of the limited liability of the seller under the definitive documents. A buyer insurance policy can give the buyer a competitive edge as a bidder in an auction process, or secure the buyer against a distressed seller’s credit risks post-closing, or even enhance the survival and coverage of the warranties.
W&I insurance generally covers all customary warranties given in an M&A transaction. Common exclusions include warranties regarding corruption, bribery and money laundering, transfer pricing, and issues that the indemnified party had prior knowledge of. Importantly, the indemnity terms in the definitive documents must correspond with the issues covered by the policy, in order to prevent a situation where a valid claim is raised under the definitive documents but the policy fails to cover the loss.
The volume of cover provided by a W&I policy is negotiable between the insurer and the beneficiary. A policy usually covers 10-30% of the purchase price, but can extend to the entire consideration payable. Typically, the policy is obtained through a syndicate of insurers.
Insurers often require the parties involved to bear a portion of the risk themselves. In a sell-side policy, the insurers typically require the sellers to bear the first portion of a warranty claim, known as the “excess”. This means that when a claim for loss is brought by the buyer, the seller has to bear a portion of the loss before the insurers cover the remaining sum. The threshold for the policy excess is in addition to contractually agreed thresholds qualifying the indemnity under the definitive documents, such as the de minimis and aggregate liability thresholds. This is a compelling reason for sellers to insist on a buyer-side policy.
The duration of the policy cover invariably matches the survival period as specified in the definitive documents, subject to extension of the survival period in a buyer-side policy. The premium payable is calculated as a function of the policy limit, and is payable on a one-time basis for a multi-year policy. The premium is based on the nature of the underlying business and complexity of the transaction, but is typically pegged at 1.5-2.5% of the policy limit. Ordinarily, the higher the value of the transaction, the smaller the percentage of premium payable.
To conclude, while the potential of W&I insurance in India is largely untapped, foreign investors familiar with the concept in their jurisdictions are inducing domestic market players to consider the advantages that W&I insurance has to offer. Experts in the field agree that with increasing cross-border M&A activity in India, demand for W&I insurance is growing.
Faraz Khan is a senior associate and Aishwaria S Iyer is an associate at Shardul Amarchand Mangaldas & Co. The views and opinions expressed are solely those of the authors and do not necessarily reflect the official view or position of the firm.
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