W&I Insurance in M&A Deals: Benefits and Pitfalls

What is W&I Insurance?

W&I insurance, also known as Reps and Warranties insurance, provides coverage against financial loss that may arise from breaches of warranties made and indemnities given by the seller (e.g. about the target company’s financials, tax, operations, legal compliance, and other relevant matters).

It transfers the risk of a breach of these warranties/indemnities from the buyer to an insurance company. If a breach occurs, the buyer can make a claim against the policy rather than pursuing the seller directly.

It is more commonly encountered in share deals than asset deals, though this is largely because most private M&A in the UK is structured as a share sale.

Buyers are the larger consumer of W&I policies, usually in circumstances where a seller refuses to provide any recourse against them.

Usefulness of W&I Insurance

W&I insurance is particularly useful for facilitating deals, enhancing negotiations and providing post-completion protection:

 1. Facilitating Deals

• Bridge Gaps: Buyers and sellers often have differing risk appetites. W&I insurance bridges this gap by providing comfort to both parties. Buyers can proceed with confidence, knowing that insurance covers potential breaches (even in the event of insolvency), while sellers can limit their post-completion exposure.
• Speedier Closings: W&I insurance can expedite deal closings. Buyers may be more willing to proceed without extensive seller indemnities, and sellers can exit the transaction faster.

2. Enhancing Negotiations

• Negotiation Leverage: Buyers armed with W&I insurance can negotiate better terms. They may accept a higher purchase price or more favourable indemnification provisions, knowing that insurance backs them up.
• Seller-Friendly: It removes the unknowns and generally allows for a single completion payment (e.g. no deferred elements or escrow).

3. Post-Closing Protection

• Peace of Mind: Buyers can sleep better at night, knowing that W&I insurance covers potential breaches. This is especially valuable when dealing with unknown risks or complex transactions.
• Avoiding Litigation: Rather than engaging in costly legal battles, buyers can file claims under the insurance policy. This streamlines dispute resolution.

Potential Pitfalls

Potential pitfalls are high premiums, coverage limitation and due diligence:

1. High Premiums: W&I insurance premiums can be substantial, especially for high-risk deals. Buyers must weigh the cost against the benefits. That being said, the party bearing the burden of the premium payments is usually up for negotiation.

2. Diligence Challenges: Buyers must undergo thorough legal and financial due diligence to secure W&I insurance. Insurers scrutinise the deal and due diligence carried out, potentially uncovering issues that impact coverage (leading to exclusions).

3. Coverage Limitations

• Deductibles: Policies may have deductibles, meaning the buyer bears some risk before the insurance kicks in.
• Exclusions: Policies often exclude known risks or pre-existing issues. Buyers should carefully review policy terms to understand what is covered. This is exemplified by the recent case of Project Angel^[1] (see below).

Cautionary Tale

Despite the many draws of W&I Insurance, it should be borne in mind that not even W&I insurance can offer full proof protection, as evidenced by the recent case of Project Angel.

The case centered around a W&I insurance policy taken out by a buyer (Project Angel Bidco Ltd) in relation to the purchase of Knowsley Contractors Limited (trading as King Construction).

Project Angel claimed under the W&I policy due to alleged breaches of the anti-bribery and corruption (ABC) warranties, resulting in a business reduction for King Construction.

Although the cover sheet of Project Angel’s W&I policy listed ABC warranties as being “covered”, the detail of the policy included an ABC exclusion, which excluded any loss “to the extent that it arises out of… any ABC Liability” with ABC Liability defined as, “any liability or actual or alleged non-compliance…in respect of Anti-Bribery and Anti-Corruption Laws”. The effect of which was to exclude any cover for any loss that resulted from a breach of the ABC warranties.

Project Angel contested that there was a drafting error within the exclusion, and it should be reinterpreted as “any liability for actual or alleged non-compliance…in respect of Anti-Bribery and Anti-Corruption Laws” so that the policy should have only excluded breaches relating to liability.

The High Court and Court of Appeal both found in the insurers’ favour, on the basis that:

• the underwriters had a coherent and rational reason for wanting to avoid liability for loss arising out of ABC Liability; and
• in order to correct a drafting mistake by interpretation, it is necessary not only that the mistake must be clear, but also that the cure must be clear (it was not clear to them whether the error (if any) lay in the drafting of the ABC Liability exclusion or the cover sheet).

Comment

W&I insurance is a powerful tool in the M&A toolbox. It facilitates deals, protects parties, and enhances negotiations. However, buyers and sellers must weigh the cost and time implications of W&I insurance, and ensure they understand the policy terms.

The decision in Project Angel serves as a crucial reminder that even if a warranty is labelled as ‘covered’ in an appendix to a W&I policy, it is essential to consider the contract as a whole. Specifically, parties should pay close attention to the relevant exclusion clauses within the body of the policy. We would also recommend proofreading the policy before agreeing to any of its terms, and looking out for any inconsistencies or drafting errors (after-all, this case came down to a single letter changing the entire meaning of the exclusion (as alleged by the buyer)).

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[1] Project Angel Bidco Ltd (in administration) v Axis Managing Agency Ltd (as representative of Syndicate 1686 at Lloyd’s of London) and other companies [2024] EWCA Civ 446