“Get the deal across the line”
Real estate transactions are no different from any other M&A deal (e.g., selling a trading business), in that the parties’ interests are often far from aligned.
The buyer will typically want any warranties and or tax covenants in the sale and purchase agreement (SPA) to be as extensive and unqualified as possible, giving it the best chance of making a claim should the need arise. The seller(s) will typically want to limit any warranties – giving it the cleanest possible exit. The seller may also not want any sale proceeds deferred, retained or held in escrow.
These differences between the parties’ expectations could easily result in a deal not proceeding. Warranty & Indemnity (“W&I”) insurance is a specialist insurance policy which is increasingly being used in M&A deals to bridge that gap. Historically predominantly used in private equity exit deals, W&I insurance has now become more prevalent in other types of transactions. It has become commonplace on corporate real estate transactions.
W&I insurance is designed to cover against financial loss that may arise from a breach of warranty in an SPA or other transaction document such as a management warranty deed or, on a share sale, from a claim under a tax covenant.
Two types of policy
There are essentially two types of W&I insurance policy, depending on whether the policy is taken out by the buyer or the seller. W&I insurance was originally conceived of as a sell-side product, providing sellers of owner-managed businesses “sleep-easy” cover in respect of the recourse buyers had against them under the warranties and tax indemnities in the SPA. However, the vast majority of W&I insurance policies today are taken out by buyers, often in the context of deals where recourse against the seller under the sale agreement is nil or anticipated to become difficult or lengthy. This does not necessarily mean that the premium is paid by the buyer – this is a matter for commercial negotiation.
What are the benefits of W&I Insurance?
The benefits of W&I insurance to a seller include:
- Allowing individual sellers to make a clean exit and use his or her sale proceeds immediately – for example to retire or invest in another deal – without the risk that they will later become liable for a warranty claim.
- Allowing institutions or pension funds to immediately distribute sale proceeds to investors and/or lenders.
- Reducing the need for a retention or escrow account (whereby some of the sale price is set aside until the warranty period has expired).
- Cover for the costs of defending against a claim.
- Where a seller is selling for a nominal amount, but the buyer still expects warranties to be given as part of the transaction.
- Enhancing the value of the transaction (i.e., the price) by allowing full warranty provision to be made in circumstances where the sellers would otherwise be unwilling or unable to give warranties.
Equally important, however, are the benefits that W&I insurance can give to a buyer where:
- They are concerned about the sellers’ covenant strength – claiming under a W&I policy removes the risk that a seller will not be able to pay out should a warranty claim arise.
- The acquisition is to be debt-financed, as negotiations with lenders may be helped by the knowledge that a W&I policy will be taken out.
- The business is being sold at auction and the buyer needs to distinguish itself from other bidders – a W&I policy can be used to provide the full warranty coverage that the buyer requires without leaving the sellers on the hook, benefitting both parties. A seller might also be willing to entertain a lower offer if they know that the sale proceeds will be immediately available to them, rather than having the uncertainty of waiting out a warranty period or having money held back in an escrow account.
In the current challenging economic climate, there has been a marked increase in the number of M&A deals where the sellers are unable or unwilling to provide more than the basic warranties and indemnities. W&I insurance can provide a cost-effective solution when it comes to closing (or even retrieving) property transactions.
The role of Cox Mahon
W&I insurance is a specialist class of insurance underwritten by a select number of insurers. Cox Mahon are specialist insurance brokers whose role is to provide advice and guidance through the entire insurance process, on policy scope and resultant benefits, collating the required information and liaising with underwriters.
Contact us today to discuss who you and your clients can benefit from W&I insurance.
Cox Mahon planning a webinar on this subject, to expand upon the content of this article. Email us today to register interest in this future event.