Warranty and Indemnity insurance: an upcoming trend as alternative source of recourse

This article is the first of a series of short articles on the merits of Warranty and Indemnity insurance (W&I insurance) used in Dutch M&A transactions. In the last couple of years the use of W&I insurance in the Dutch M&A market has significantly grown.

In M&A transactions, one of the matters heavily debated between sellers and purchasers relates to the scope and extensiveness of the representations and warranties and the form of recourse a purchaser seeks from a seller as security for the payment of any warranty claims in the event of a breach of a warranty. There is an obvious gap between the interest of a seller to limit liability risk and financial exposure and a purchaser seeking to obtain maximum reliance and security from a seller. To bridge this gap Warranty and Indemnity insurance (W&I insurance) could be considered as a solution which is satisfactory to both the seller and the purchaser.

W&I insurance insures a party against losses resulting from a warranty or (tax) indemnity claim under a share sale purchase agreement or an asset sale purchase agreement. There are grosso modo two types of W&I insurance available on the market today, a so-called sell-side policy under which the seller is indemnified by the insurer, and a buy-side policy under which the purchaser is indemnified by the insurer for any losses resulting from warranty or (tax) indemnity claims. Although a sell-side policy is relatively uncommon it could be useful for investment funds which are at the end of their lifecycle and need to "wind up". More commonly used, however, is a buy-side policy.

Note that not all deals are insurable. W&I insurance is obviously not meant to replace due diligence or to cover issues already known to the insured. An insurer would typically expect to receive proper due diligence reports (at least on tax) covering all material (legal and other relevant) aspects of the target; when a professional purchaser has the in-house knowledge and capacity to conduct its own due diligence without the need for hiring external specialists it is important to note that an insurer would still like to receive written internal reports so as to verify the scope and thoroughness of the diligence performed. As a rule of thumb, if and when a transaction has not been managed, diligenced and negotiated if there was no W&I insurance in place, it is very likely that there will not be any real appetite amongst insurers to provide cover.