warranty and indemnity insurance

Stapled W&I policies and synthetic policies will likely be increasingly common features of E&I transactions, although their feasibility should be assessed case by case.

By Simon J. Tysoe and Devdeep Ghosh

Warranty and indemnity insurance (W&I) is a long-established feature of M&A transactions in Europe, especially with private equity sellers. The 10th edition of the Latham & Watkins Private Equity Market Study shows that nearly 48% of all European M&A transactions in 2023 involved W&I with 65% of private equity sellers favouring W&I-backed exits. However, on the flipside, our market study indicates that on an aggregate basis only 35% of energy and infrastructure (E&I) transactions involved W&I, with varying levels of adoption across European geographies.

Certain recurring characteristics of E&I transactions could explain the dislocation in this trend: the sometimes challenging nature of the assets and jurisdictions for these transactions and the assets themselves frequently having a fragmented shareholder base, which usually means that there are no negotiated business warranties to be covered.

Along with a recent softening of the W&I market, two developments can help bridge this gap for E&I transactions: stapled policies and synthetic coverage.

Warranty and indemnity insurance may remain a staple of European private equity, but are buyers changing course?

By Neil Campbell, Tom D. Evans, Sebastian Pauls, Maximilian Platzer, David J. Walker, Edward Coates, and Catherine Campbell

Warranty and indemnity (W&I) insurance has become an important component of European PE transactions in recent years. However, changing market dynamics and challenging macro conditions (which have cooled deal flow) mean that PE buyers are now more critically evaluating the merits of W&I insurance. The Eighth edition of the Latham & Watkins Private Equity Market Study indicates that the overall uptake of W&I insurance is beginning to plateau, having increased significantly between 2016 and 2019. From a high of 35%, overall usage of W&I insurance in European deals has dropped in the past two consecutive years.

As W&I insurance has matured and PE buyers have become more experienced consumers of the insurance (and of low or nominal liability caps for warranties), the emerging picture is one of a product with a nuanced value. Increasingly, deal-specific characteristics, structures, and issues are playing a role in the demand for and success of W&I insurance, including appetite for stapled policies.

Increased competition among insurers and improved policy terms suggest the German W&I insurance market is becoming more favourable to investors.

By Christian Thiele

In real estate transactions, buyers and sellers naturally pursue conflicting interests when negotiating a sale and purchase agreement. On the one hand, sellers will strive to achieve the highest possible purchase price, and will also want to keep their liability exposure low. Private equity investors in particular will try to achieve a “clean exit” when selling real estate directly or indirectly, so that they can dissolve the selling entity quickly. On the other hand, buyers will want to minimize the purchase price. At the same time, they will know the asset only from their due diligence. Therefore, buyers will try to obtain a comprehensive set of representations and warranties from the seller. However, even if the seller gives such representations and warranties, asserting claims will often be unsatisfactory for the buyer because the selling entity lacks assets. The buyer will therefore insist on a security for his claims. These conflicting interests often put a significant burden on contract negotiations and can even turn into a deal-breaker.

Sell-and-buy-side W&I policies

Parties to a deal can secure the buyer’s claims in different ways, such as a purchase price retention or escrow accounts. In the current seller’s market, however, such structures are becoming increasingly rare. So-called warranty and indemnity insurances (W&I insurances), however, are becoming an increasingly popular method of securing the buyer’s claims. Either the seller or the buyer can take out such W&I insurances. If the seller takes out the insurance, the insurer reimburses the seller — similar to a liability insurance — for claims asserted by the buyer. Such policies have risks for the buyer, e.g., if the seller acts intentionally or violates his obligations under the insurance policy and the insurer refuses to reimburse the damage. Sell-side W&I policies, therefore, have almost no practical relevance, at least in real estate private equity transactions. The buyer’s preferred option is the buy-side W&I policy. Such policy grants the buyer a direct claim against the insurer in case of a damage. The buyer, therefore, does not have to assert any claims against the seller. Such policies also cover instances in which the seller has not disclosed the relevant facts and has therefore acted with gross negligence or even intentionally.

By Nick Cline, Dan Treloar, Katie CampbellPencils_sngleColClr

Warranty and Indemnity (W&I) insurance, which seeks to bridge the gap between a buyer’s wish for deal protection and a seller’s desire for a clean exit, has become a common product in European M&A transactions. In our view, there is real value in having a thorough understanding of the process and key practical considerations for acquiring a policy. 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 where W&I insurance was used has increased, with around 13% of transactions now using the product. Claims data compiled by AIG (R&W Insurance Global Claims Study) indicates that claims are filed against around one in seven W&I policies globally, suggesting real protection for both buyers and benefit to sellers that would otherwise be exposed to such claims.

Planning, Timing and Readiness

In both bilateral and auction sale processes, strategic bidders can enhance the deliverability of their offers by addressing W&I insurance early in the process. Bidders can present themselves as “dealready” counterparties that pose a lower execution risk than rival bidders. Early engagement with brokers and lawyers will also reduce the risk of coverage gaps and ensure a smoother process. Brokers can also seek beneficial terms and leverage any competitive tension between underwriters earlier in the process.