PEViews3By Neil Campbell and Leif Schrader

Warranty and indemnity (W&I) insurance products have been marketed as a “silver bullet,” which can bridge the gap between a buyer’s wish to receive proper deal protection and a seller’s aim of a clean exit. However, as the market continues to mature, insurers are becoming cautious and terms are tightening. In our view, recent developments in insurance practice pose new practical issues for buyout firms, particularly on German deals.

According to the Latham & Watkins 2016 European Private M&A Market Study, which examined over 170 deals signed between July 2014 and June 2016, the proportion of transactions employing W&I insurance has increased over 60% since Latham’s 2015 survey. As expected, W&I insurance is most prevalent in sales by private equity sellers. Recent claims data compiled by AIG (R&W Insurance Global Claims Study 2016) indicates that claims are filed against around one in seven W&I policies globally, suggesting real protection for buyers and also benefit for sellers, who would otherwise have been the addressees of such claims.

However, such claims have resulted in significant payouts, particularly against financial and tax warranties. A relatively large proportion of claims come from continental Europe, with insurers reporting further large European losses pending. Consequently insurers, particularly in Germany, are increasingly conservative and are reflecting their claims experience in the terms on offer. There is greater reluctance to cover matters outside the scope of due diligence (even on a knowledge qualified basis) and insurers are less willing to compromise on general exclusions such as property and pension payments. In addition, while W&I insurers have always required sight of transaction documentation, German W&I insurers are now reviewing deal terms in more detail and are imposing their own requirements, such as warranty bring-down at closing. While this is typically for insurer information purposes only, buyers and sellers must carefully review transaction documentation alongside the insurance policy to ensure that any seller disclosure does not inadvertently release the insurer or expose the parties to additional risk or liability.