Mergers & Acquisitions - Warranty, Indemnity and Tax Risk Insurance
Warranty and Indemnity Insurance
As part of the acquisition of a private company, a Buyer will require the Seller to give warranties and indemnities (including a tax covenant) confirming the status of the company/group being sold. These warranties play an important role in the transaction as a Buyer is relying upon the same together with various indemnities and covenants to confirm the status of the target company /group.
Warranties are a Buyer’s requirement, and the Seller ultimately has to give such confirmations as the Buyer may require to justify the purchase price for the target company. Further complications may arise if the Buyer is looking for security for any of the warranties given by the Seller, and as a tax covenant can last for 7 years after completion a Seller may be reluctant to provide any additional security.
There are also certain categories of Sellers who are typically not prepared to give these confirmations, including private equity sellers, various funds and sellers who have no management involvement with the company being sold.
In order to meet the Buyer’s requirements and the Seller’s inability (or unwillingness) to give warranties the insurance market offers warranty and indemnity insurance (W&I Insurance)
whereby the risk of breaches of warranties, indemnities and covenants is covered by insurance.
The risk covered by insurance is the unknown risk of a claim, for instance, if a Seller concealed material information or knew of something which it ought to have disclosed to a Buyer, this would not be covered.
W&I Insurance is typically obtained by the Buyer who may recover the cost via a reduction in the purchase price. Buyers should be aware that their policy will contain an excess, but given that the Buyer often accepts that practically they would be unable to claim for small claims (which is normally claims up to 1% of the purchase price) a commercial view is frequently taken in this regard.
W&I insurance is typically only appropriate where the target company is relatively clean, such as for property company sales, and it may not be so easy to obtain insurance whether there is a trading company with multiple contracts. The insurance does not cover everything, such as environmental and tax risks, and would be expected to exclude matters that are disclosed by the Seller.
The cost of the policy will vary but is normally around 1%-2% of the purchase price plus professional costs (as all the transactional documents will need to be reviewed by the insurer’s lawyers - this will add additional time to any transaction and should be borne in mind when considering timescales as a result cover may not be economical for all merger and acquisition transactions.
From a Seller’s perspective, W&I insurance is good way around the potential liability posed by the Buyer’s required warranties and indemnities but the Seller has to remember that insurance will not cover any fraud by the Seller including wilful concealment of matters. In such a case the insurer and the Buyer may have a direct claim against the Seller.
The Buyer’s solicitors will have to carefully consider the terms of any policy to ensure all risks are covered and in particular there are no material exclusions which could make the policy worthless. The underwriters also need to be considered to ensure they are able to meet a claim.
The Seller must also remember they must fully comply with the Buyer’s due diligence process and give full disclosure against warranties where appropriate.
Tax Transaction Insurance
A W&I policy is there to effectively cover the Buyer/Seller against what are unknown risks. However, from time to time there may be certain matters which are known to pose a risk whilst the outcome of said risk is not certain. This usually applies where the matter hinges upon a third-party determination, such as HMRC’s determination as to the tax treatment of a transaction, it may not be possible or desirable to obtain an advance ruling.
In these circumstances it may be possible to obtain W&I insurance to cover the tax risk, although this is normally costlier than standard W&I insurance as it is looked at in detail by the underwriters and the known risk fully assessed by the insurers.
In order to enable the insurers to provide a quotation, the parties to the transaction would need to produce an opinion (normally from Counsel although it could be from solicitors/accountants) setting out the position and preferably taking a favourably robust view on the position. There is no obligation on any insurer to accept any risk and tax and transaction insurance can be difficult to place.
Anthony Harris is a Company Commercial partner at CBG Law and specialises in advising companies undertaking mergers and acquisitions. If you would like to understand whether W&I Insurance could benefit a proposed company acquisition or disposal then please contact Anthony Harris on 020 7462 6022 or ahh@cbglaw.co.uk .