The number of cross border M&A deals in India has steadily been increasing. As M&A transactions are gradually becoming more sophisticated, representations, warranties and indemnity clauses remain the most heavily negotiated clauses. Buyers and sellers negotiate exhaustive lists of representations and warranties, exclusions to the indemnity obligations and other limitations to indemnity liabilities (including survival, cap, de-minimis and basket amounts). However, the concept of warranty and indemnity insurance (W&I Insurance), which is well recognised globally and used as a mechanism to bridge the gap between the parties’ negotiating positions, has still not been adequately tapped in India.
W&I Insurance concept
As the name suggests, W&I Insurance is an insurance product covering contractual warranties which range from fundamental warranties, business warranties, tax warranties to transaction specific warranties. W&I Insurance is a tool to protect both the buyer and the seller against financial loss resulting from a misrepresentation in, or breach of the warranties. It covers parties for any unknown claims which come up post completion of the transaction and relate to the period prior to completion. There are two types of W&I Insurance “Buyer-side Insurance” and “Seller-side Insurance” based on the party insured (and not the party who pays the premium).
Under a Buyer-side Insurance policy, a buyer is the insured entity/individual and the trigger for the insurance is loss suffered due to breach or inaccuracy of representation or warranty provided by the seller. The sum assured can extend beyond the indemnity coverage under the transaction document (with respect to time limits and caps). The buyer can directly claim under the insurance policy without raising contractual claims against the seller under the transaction documents.
Under a Seller-side Insurance policy, a seller is the insured entity and the trigger for the insurance is breach or inaccuracy of seller’s representation or warranty. The coverage of the insurance cannot extend beyond the seller’s liability under the transaction document. In such policies, the buyer raises contractual claims against the seller and the insurer then reimburses the seller for losses incurred and claims paid.
Globally as well as in India, we have observed that Buyer-side Insurance is more common than Seller-side Insurance. The specific terms of each policy differ based on the transaction and the negotiation strength of each party. Parties usually chose to obtain insurance for 10% – 40% of the deal value wherein insurance retention varies from 1% – 2% of the enterprise value and the premium varies between 2% to 3.5% of the insurance limit.
While the usage of W&I Insurance is gradually increasing in India, it is still not commonly used in transactions. It still remains untapped largely due to parties’ unawareness about its benefits and perception of the premium costs being high. In addition, parties’ are sceptical about the coverage of such policies which contain certain standard exclusions such as losses arising out of bribery and acts of corruption, transfer pricing issues, specific indemnity matters which were discovered during the diligence process, contingent liabilities and risks known to the insured or disclosed before completion of the transaction.
Why should a buyer negotiate for W&I Insurance?
The significant reasons for a buyer and the buyer’s lawyer to require W&I Insurance cover from the counter party are:
It provides for speedy recovery of money. In India, litigation may take many years to settle the matter whereas if the insurance claim is valid then W&I Insurance can provide speedy recovery from the insurer within a comparatively shorter period of time.
It can provide a sense of security to the buyer who is investing in a foreign jurisdiction and is not confident about the risks associated with the regulatory framework and uncertainties in law.
It offers protection to the buyer in addition to the indemnity provisions contained in the transaction document which may be heavily negotiated, time bound and otherwise restricted including by way of being capped to a specific amount.
It provides financial comfort to the buyer in case of any uncertainty with respect to a seller’s financial position to meet any indemnity obligations (more relevant if the seller is an individual promoter).
It can work as the financial security lookback in case the seller, being a private equity player or a passive investor who was not involved in the day-to-day management of the company, is not willing to give any business warranties.
It provides protection to the buyer against any fraud of the seller and gives a realistic ability to the buyer to recover losses arising out of fraud of the seller.
In case of a partial management buyout, W&I Insurance mitigates the requirement of asserting claim against the management sellers and helps preserve the ongoing key relationship with the sellers.
In a bid or an auction situation, buyers can use W&I Insurance to be more flexible on seller indemnity obligations and make the bid more appealing.
Why should a seller negotiate for W&I Insurance?
Similar to the buyer’s side, there are varied reasons for a seller and the seller’s lawyer to negotiate for a W&I Insurance, the most significant ones are:
It helps the seller to negotiate a lower indemnity obligation by shifting part of its indemnity obligation on the insurer by obtaining W&I Insurance. If the seller, being a private equity player or a passive investor, does not wish to provide any business warranties, then such seller can provide comfort to the buyer by obtaining W&I Insurance.
It facilitates a clean exit to the seller. With the help of W&I Insurance, the seller can negotiate for least possible recourse and endeavour to exit completely upon completion of the transaction.
It provides adequate assurance to the buyer for addressing any future liability and enables the seller to negotiate a reduced or totally eliminate the need for a seller escrow or holdbacks for unknown liability.
It facilitates the seller to negotiate a better valuation of the deal since consideration or the valuation need not be adjusted or set aside for unknown liabilities which can be addressed by the W&I Insurance.
In case of a transaction involving multiple sellers, it can provide protection and an alternative to the minority and passive sellers who are not comfortable in providing joint and / or several indemnity to the buyer.
W&I Insurance is beneficial for both buyers and sellers. It bridges the gap between parties’ perception of the amount of risk and liability that each party should bear. It also facilitates reduction or elimination of exposure to the seller due to breach of warranties and provides protection to the buyer against loss due to breach of warranties. While, it cannot be considered as a panacea for all risks and there is a cost associated with obtaining it, it definitely allows parties to efficiently allocate risk, negotiate and close deals faster.
This article is authored by Vineet Shingal, Associate Partner and Vidushi Gupta, Senior Associate, at Khaitan & Co.