Stephen Roberts: Well, there's a number of different reasons why you might consider adopting a warranty and indemnity insurance policy, both from the perspective of the seller and from the buyer. So there's a number of advantages to incorporating warranty and indemnity insurance into your transaction. From a seller's perspective, first of all, it might help the seller sleep at night knowing that actually instead of being sued under the terms of the SPA, in the event that there is a warranty claim, that actually the buyer would be bringing a claim against the insurance company as opposed to them. So they have more certainty that they can keep the consideration that they've received for their business.
Stephen Roberts: And from a buyers perspective, there are a number of benefits to having insurance in place. Perhaps the most obvious benefit is if a buyer is buying into a management team and the sellers are part of that management team and they're staying on in the business, a buyer will obviously be very reluctant to bring a claim against those individuals post completion. The last thing a buyer wants to be doing is bringing a claim against it's own management team. And it's probably fair to say that in those sorts of circumstances you're going to damage the relationship. Another advantage from the buyer's perspective would be that rather than suing an individual, they would be suing an insurance company and obviously an insurance company has a better financial covenant as opposed to an an individual.
Host: Sure. Okay. So what are the limitations, or are there any limitations that need to be considered when thinking about a policy?
Stephen Roberts: There are a number of limitations that need to be considered by both the buyer and the seller. This isn't a magic bullet. It doesn't make all of the concerns that a buyer or a seller would have on a transaction of this nature. What an insurer would look to do is essentially replicate the terms of the SPA in terms of its coverage. So it would try and reflect the terms of the spa and offer coverage on that basis. But there will be a number of important distinctions which the buyer and the seller need to be aware of and to consider when they're thinking about taking this sort of policy on. The most obvious limitation with this sort of policy is that the insurer will essentially assess the risk that's associated with putting this policy in place and it will only offer cover where it's comfortable with that risk and where it's sure that it understands what that risk looks like.
Host: Okay. So what are the limitations associated with a warranty and indemnity policy?
Stephen Roberts: There's a number of limitations that typically apply on policies such as this. And perhaps the most important to understand is that the buyer's knowledge will prejudice him making a claim under the insurance policy. And whereas under a sale and purchase agreement, the buyer's knowledge of a tax issue wouldn't prejudice his ability to make a claim under the tax covenant that's given by the seller. It would prejudice his ability to bring a claim under the insurance policy and quite simply that's because the insurer isn't prepared to ensure known risks. These policies are designed to cover unknown risks. So another limitation would be that insurers and underwriters are unwilling to insure areas of the business that haven't been diligent to their satisfaction. And very often you see a bit of a disconnect between due diligence that the buyer is comfortable with other than thinks is proportionate and what an insurer thinks is appropriate.
Stephen Roberts: So if for example your buyer a is carrying out an exercise, almost certainly he will do some due diligence on data protection. The insurer might have a different view of the scope of the data protection exercise that's undertaken. The insurer might expect that exercise to look more like an audit. In other words, it's not enough just to look at the policies. Actually, to what extent have you verified the extent to which the target business is actually complying with those data protection policies? And this will impact on the coverage that the insurer will give. So if the insurer is uncomfortable with the diligence that's been done in a particular area of the business, it's lightly to qualify the warranties that are given in the SPA so that the SPA would be read as if those warranties were either excluded or they were perhaps qualified.
Host: Okay, so what happens to those exclusions?
Stephen Roberts: Well, those exclusions typically form one of the key areas of negotiation on any transaction with warranty and indemnity insurance. The buyer obviously will want to say that if I can't claim against the seller under the insurance policy, I would still like to be able to claim against the sellers under the sale and purchase agreement, as if I didn't have the policy. Because the buyer doesn't want to be in a worse position than it would have been in had there been no insurance at all. From the seller's perspective, obviously they would want to be in a position where the buyer's only recourse is to the insurance policy because if the idea is for there to be a clean break and for the seller to be able to walk away knowing that there's no risk of any comebacks at a later date, that is the position that he will want to achieve.
Stephen Roberts: Invariably, the point tends to be negotiated and it will come down to the amount of leverage that both the buyer and the seller have on any given transaction. But it's fair to say that sometimes you can see there being a clean break and the buyer only having recourse to the policy. On the other hand, it may well be the case that it's simply if the buyer can't recover under the insurance policy, but does have recourse under the Salem purchase agreement, then the buyer can still bring a claim against the sellers.
Stephen Roberts: There are also a number of other exclusions and limitations to these policies that it's worth bearing in mind. Insurers are typically nervous about insuring matters such as transfer pricing or environmental issues, so they will typically be excluded from any insurance policy that's offered. Insurance is possible if the buyer and the seller do want to ensure those sorts of matters, they can do that, but it's almost always the subject of a separate policy. So as a result of the increased risk, that separate policy is likely to be more expensive.
Host: So Stephen, if I'm at the outset of a transaction which I could see involving warranty and indemnity insurance, what should I be considering at that point?
Stephen Roberts: I think if you're the buyer, there's a few things to think about. I think the first thing to think about is to what extent you incorporate the concept of warranty and indemnity insurance into your heads of terms. To what extent do you get involved in that negotiation that I mentioned about who bears the risk of uninsured claims? So a second consideration for the buyer will be the scope of its legal due diligence exercise. This will obviously have an impact on what the insurer is prepared to insure. The insurance policy and the insurer's perception of the risk will be colored by the scope and the depth of the due diligence exercise that's being carried out. Typically, the legal advisors will apply a threshold in respect of the matters that they are reviewing.
Stephen Roberts: So it wouldn't be unusual to see an illegal due diligence report, for example, that states that a matter wouldn't be perceived to be material from their perspective and from a reporting perspective, if it doesn't at least have a value of let's say £35000 to £50000. What the buyer needs to bear in mind is that the insurer will automatically exclude any claims that don't meet that particular threshold.
Stephen Roberts: One more point that a buyer may consider at the early stages of a transaction might be related to whether or not there's a competitive element to the transaction process. If the buyer is involved in an auction process, it may be that they want to consider warranty and indemnity insurance and an offer to put a warranty and indemnity insurance policy in place as part of their offer to the sellers. Obviously from a seller's perspective, an offer that includes insurance is more attractive than one that doesn't. Again, at the outset of the transaction, the buyer will probably be considering what happens to those uninsured matters that we talked about earlier. Who does bear the risk of there being a claim that's either partially or wholly uninsured?
Host: Excellent. That's really useful. So coming on to one of the key questions, how much does this cost Stephen?
Stephen Roberts: Well the good news is that premiums have been coming down in recent years and there are more underwriters than ever who are offering this sort of policy. If you were thinking about putting warranty indemnity insurance in place on a transaction, you would obviously get in touch with a broker and they would help you source the best possible deal in terms of policy pricing.
Host: So if I'm considering putting warranty and indemnity insurance in place on a transaction, how much is that likely to cost?
Stephen Roberts: The cost of the policy is typically 1% of the value of the cover that you're looking to put in place. There are a few factors that will ultimately affect the price that you have to pay for the policy and a broker will help you negotiate that process and ensure that you get the best possible price. But it will depend on, to a certain extent, namely the industry sector that the target business is within, the scope and the extent of the cover that's on offer. And actually practically, in my experience, it often comes down to how busy the particular underwriter is at any given time in terms of their appetite for more business.
Host: Okay, so that all makes sense on cost. How common are these types of policies?
Stephen Roberts: The policies are becoming more and more common and we're getting more and more questions from our clients about them. And what I would say is that it should be born in mind whenever you're doing a transaction of this nature. Come and have a conversation with us. Let's talk about whether this sort of insurance policy is right for you and for your transaction. It's fair to say that on a number of transactions that we've worked on recently, warranty and indemnity insurance has added a fair bit of value to both the bias on the sellers on the transaction.
Host: Excellent. Thank you for that overview Stephen. And for anyone listening to the podcast, Stephen's details will be available on page and on our site should anyone have any questions for him.
Host: Thank you for listening to Straight Talking Business Success. To find out more about the series, please visit gateleyplc.com/businesssuccess. From here, you can subscribe for updates, meet our speakers, and get more information on all of the topics that we've covered.