W&I insurance in a company acquisition: covering warranties and enabling a clean exit

W&I insurance covers losses that arise to the buyer from a breach of the seller warranties. Instead of turning to the seller, the buyer turns to the insurer. This brings advantages to both sides. The seller can sell the company and release itself from liability, the buyer keeps a solvent counterparty for claims.

For sellers the so-called clean exit is the greatest benefit. Financial investors and succession sellers in particular want to use the proceeds freely, without having to set aside provisions for possible warranty claims over years. The policy takes over the liability and enables a clean departure.

For buyers it is above all the credit standing that matters. A warranty is only worth as much as the solvency of the party that gave it. If the seller is a holding without substance or a private individual, the policy gives the buyer a solvent counterparty for claims. The concept we explain in the glossary.

A W&I insurance can be taken out by both sides. With the buy-side policy the buyer is the policyholder. If a warranty case arises, it asserts the claim directly against the insurer. This variant is the most common, because it protects the buyer directly and enables the seller clean exit.

With the sell-side policy the seller is the policyholder. In a warranty case the buyer first turns to the seller, which in turn calls on the insurer. In practice a sell-side structure is often set up at the start and switched to a buy-side policy in the course of the negotiation.

Which structure fits depends on the negotiating situation and the aim of the parties. Anyone on the seller side will find further guidance in the post on the earn-out as a variable part of the purchase price.

A policy never covers everything. It responds to a breach of the insured warranties but remains limited by the retention and the de minimis threshold. The retention is the amount the policyholder bears itself before the policy steps in. The de minimis threshold excludes trivial losses.

Typically excluded are risks that became known in due diligence. Whoever knew of a risk cannot insure it. Likewise usually excluded are forward-looking statements about future development, and often taxes or environmental risks are handled separately or excluded entirely. These gaps must be caught through the purchase contract.

It is precisely the treatment of the exclusions that decides the value of the policy. An initial assessment of the risks is provided by our M&A transaction risk profile, which makes the central risk areas of a transaction visible.

W&I insurance does not stand on its own. It intervenes in the liability architecture of the purchase contract and must be aligned with the warranty catalogue, the liability cap and the indemnities. A warranty that is in the contract but not insured otherwise runs empty or burdens the seller despite the desired clean exit.

In practice the seller liability is often limited to a symbolic amount, while the actual protection runs through the policy. For the uninsured risks, such as known tax questions, separate indemnities are agreed. In this way an aligned system of contract and insurance arises.

For this system to hold, the contract and the policy must be negotiated in one go. How the warranty catalogue is built in this is shown in the post on the warranty catalogue in the purchase contract.