Corporate Finance Insurance Brokers > Warranty and Indemnity Insurance
A Brief Explanation
Sale of companies
When companies (or assets of companies) are sold, the vending shareholders are usually required by the purchaser to make statements about the company at the point of sale. These statements, or warranties, cover every aspect of the company from financial information and trading environment to litigation and pensions. If the vendors are aware of matters which would make any warranties incorrect they should disclose such matters to the purchaser. If, however, the vendors give warranties which are, subsequently, shown to be incorrect and the offending matter has not been disclosed, the purchaser has the right, under contract, to recover the difference in the purchase price between what he paid and what he would have paid had he been made aware of the offending matter. This is warranty liability.
Types of W & I
Traditionally, W & I was bought by vendors as a way of protecting themselves against the possibility of warranty liability claims eating away some or all of their proceeds from the sale of their shares. This is known as vendor cover and is the most frequently bought form of W & I. A feature of vendor cover policies is that if the purchaser can prove breach of warranty the vendor’s policy pays out the proceeds to him without having to pass through the vendor. The benefit here is that any concerns that purchasers may have regarding the vendor’s ability to pay in the event of a proven claim, are satisfied.
With an increasing number of transactions nowadays involving exits by private equity and venture capital funds who are unwilling to give warranties other than to title. W & I insurance is the only way to give sufficient cover In addition purchaser top-up cover is available to management for their liability over and above their share of consideration.
Purchaser Top-Up Cover
This type of cover is based on managers providing warranties in the normal way and accepting liability to the purchaser under contract for their percentage of the consideration. If the purchaser is not satisfied with the protection this affords, he can buy a policy in his own name covering his loss arising from his inability to recover the full extent of the damage flowing from the breach of warranty due to contractual limitations. Instead of the traditional third party liability policy, this is a policy which covers first party loss.
Purchaser top-up cover is still based on the premise that the purchaser must always prove breach of warranty by the managers/warrantors under contract before being in a position to recover under this policy. There are two further extensions to the first party theme which go even further away from third party liability. These are “purchaser first resort” cover and “purchaser last resort” cover.
Purchaser First Resort Cover
Where the vendor is willing to provide warranties but is not prepared to accept any liability for the consequences of any of them being incorrect, the purchaser can buy his own policy covering his loss arising from any of those warranties being incorrect. Instead of having to prove breach of warranty against the vendors he has to prove to insurers that he has suffered loss.
Purchaser Last Resort Cover
Occasionally, purchasers enter into transactions with concerns regarding the vendor’s ability to pay proven warranty claims. They could insist that the vendor takes out W & I and names the purchaser as “loss payee”. However, there is a risk that the policy fails to respond as a result of events outside the purchaser’s control, thereby leaving the purchaser out of pocket. In such circumstances, the purchaser can buy his own policy which covers his first party loss arising out of this inability to recover on a justified claim due to the impecunity of the vendor. The policy will stipulate that the purchaser must have exhausted all other avenues of recovery before any claim is paid.
Extent of Liability
Liability normally arises under a schedule of general warranties and also under a Taxation Deed of Indemnity. The period of liability will normally last up to three years under the general warranties and up to six years in respect of tax liability.
A policy of insurance can be arranged to run concurrent with these periods which does not contain a cancellation clause.
Who should consider insurance?
Any party to a corporate transaction including
- Individual and company vendors giving warranties in a Sale and Purchase Agreement
- Purchasers who wish to secure their right of recovery in the event of a successful breach of warranty claim
- Institutional vendors including venture capitalists who seek a clean exit without any continuing liability under warranties or representations.
- Vendors or Purchasers looking to cap the cost of Known Environmental Pollution liability
- Investors looking to protect financial resource under warranty claims against a management team which has limited financial resources
- Vendors or Purchasers wishing to provide additional security in cases where a corporate vendors balance sheet is weak or where the corporate warrantor is offshore