How insurance lawyers can enhance warranty & indemnity insurance policies
Warranty and indemnity (‘W&I’) insurance is now a well-established product for parties in corporate transactions and, for deals of a certain size, is frequently taken out as a matter of course.
W&I insurance policies can be taken out either by sellers or buyers of businesses to provide cover from a loss sustained by the buyer which is connected to either a valid breach of a warranty or a claim under a tax indemnity in an acquisition agreement.
Buyers and sellers will have different drivers for using a W&I product. For example, a seller may consider taking out a W&I policy to limit its exposure under the acquisition agreement and achieve a clean exit by freeing up the sales proceeds. On the other hand, a buyer may want a W&I product if it does not have faith in the strength of the covenant being given by a seller with a poor balance sheet, or if there are robust caps on the seller’s liability in the acquisition agreement.
W&I policies add an extra layer of protection for the parties in corporate transactions and often can be dealmakers. Although the increased prevalence and use of W&I policies has brought about greater standardisation in policy wording, they should not be thought as ‘off the shelf’ products. W&I policies require scrutiny and negotiation to ensure there is as much parity as possible with the acquisition agreement.
Here are THREE REASONS why corporate lawyers ask us to be part of their advisory team when putting a W&I policy in place:
1. INSURANCE LAWYERS KNOW HOW UNDERWRITERS THINK
When deciding to write the risk, underwriters put the target, the sellers, and the buyers under the microscope to build a picture of the deal and determine the level of risk they are prepared to accept. The problem is that underwriters build this picture usually by reference to the acquisition agreement and due diligence materials only. If there are holes in these materials, underwriters cannot build a clear image of the deal and any draft policy is likely to be littered with exclusions. This can be exemplified where the target, the buyer, or the seller exist in a regulated environment. Luckily, we are fluent in regulation.
Before you hand over the acquisition agreement and due diligence materials to the insurance broker, let insurance lawyers perform a litmus test to see if the deal picture is complete and in focus. If you have already provided these documents and the underwriter is scratching their head, you will find having an insurance lawyer join and lead a call with the underwriter, the insurance broker, and the advisory team can help lift any fog, so the underwriter better understands the risk.
2. INSURANCE POLICIES ARE WEIRD
Octopuses and mussels are both molluscs, but they are quite different - the latter feels no pain and goes well with chips, while the former has three hearts, a complex nervous system, and blue blood. In the same sense, insurance policies are contracts, but because of their evolutionary history and the regulated ecosystem in which they exist, they behave very differently to other forms of commercial contract.
For example, it is not so important if you breach a warranty in a commercial contract; sure, it might give rise to damages, but unless the contract stipulates otherwise, the counterparty will not be able to terminate. Breach a warranty in an insurance contract, however, and you could find yourself without cover until the breach is remedied. Insurance contracts are weird, but insurance lawyers deal with them all the time and with one on your advisory team they will identify tricky provisions in the policy, help you and your client understand them and even suggest drafting changes to be negotiated via the insurance broker.
3. THE INSURANCE ACT 2015
The Insurance Act 2015 reformed insurance contract law in relation to disclosure and misrepresentation, warranties and other key terms, and insurers remedies. Its aim was to redress the power imbalance between insurers and commercial insureds. Especially for buy-side policies, W&I products operate so that, broadly speaking, matters which are disclosed during the transaction process or which are in the knowledge of the insured before inception of the policy are excluded from cover. Such matters will fall within the ambit of the information which the insured must disclose to the insurer to satisfy their duty to fairly present the risk pursuant to the Insurance Act 2015.
It is common to see W&I policy wordings ‘contract out’ or modify the statutory rights and obligations of both the insured and the insurer. These modifications are designed to put the insured in a better position by reducing the scope of what constitutes knowledge in relation to a fair presentation of the risk and by limiting the insurer’s remedies for a breach of the insured’s duty to fairly present its risk. These beneficial changes can, however, conceal other deviations from statute, which put the insured in a worse off position. Because of the standardisation of wordings, these hidden traps are ubiquitous, but insurance lawyers will know where to look and they will be able to quickly spot these subtle deviations and suggest alternative drafting to be negotiated via the insurance broker.
What every policyholder wants when taking out a policy is to know what is insured, what is not insured, and that the policy will respond if called upon. Having an insurance lawyer with policy drafting experience on your side with maximise the chances of your client achieving this.
For further information, please contact Josh Bates.