W&I Insurance protects buyers & sellers in M&A deals from financial losses due to breaches. Growing significance in GCC region as market expands.
Anand SinghSenior Counsel, Transport & Insurance
Veena ShankarParalegal,Transport & Insurance
In a merger and acquisition transaction (M&A transaction), a seller is required to provide various warranties and indemnities in relation to the transaction. Warranties are declarations of information about the business, granting the buyer the right to initiate a claim against the seller if any of these statements are discovered to be incorrect or untrue. Further, indemnities are contractual provisions that provides protection to buyer against the seller against potential losses or liabilities which may arise from a certain specified event or circumstances.
W&I Insurance is a specialized transaction risk insurance product designed to provide cover against the financial loss that may arise from the breach of warranty or indemnity under an M&A transaction.
In M&A transaction buyers are keen to verify the accuracy of the seller's representations and warranties, while sellers strive to minimize their liability under the transaction. In this context, W & I Insurance acts as a powerful tool that offers desired protection to both parties and facilitates the transaction.
W&I Insurance is designed to protect the insured (either the buyer or the seller) from the potential financial loss arising from breach of the seller’s representation, warranties and tax covenant given in the underlying share purchase agreement executed between the parties (SPA). The W&I Insurance could play a crucial role in an SPA by enabling the seller to mitigate their liability while simultaneously offering the buyer the desired level of protection.
This insurance can be secured either by the buyer or sellers in the transaction as the key aim of this insurance is to protect the insured from the financial loss arising from or in connection with the breach of the Seller’s warranties and representation. However, it tends to be more beneficial for the buyer as it provides coverage to certain losses which are otherwise not available under seller procured W&I Insurance. For instance, the buyer-side W& I Insurance extend to cover losses resulting from the seller’s fraud which is not covered under a seller-side W&I Insurance. Also, under a buyer-side W&I Insurance, the buyer can claim directly from the insurer in the case of breach of a warranty with no obligation to first claim against the seller. However, under a seller-side W & I Insurance policy, the seller suffers the loss and then brings the claim against the insurer.
For securing cover in any type of insurance product, the insurers rely on the information declared by the customer, based on which the underwriting of risk is carried out and the quotation is issued by the insurer. Similarly, for a W&I Insurance product, the insurer relies on the information declared by the customer (whether buyer or seller) which includes the due diligence report drafted to identify the potential risk/red flag in the business.
For securing cover in any type of insurance product, the insurers rely on the information declared by the customer, based on which the underwriting of risk is carried out and the quotation is issued by the insurer.
In most cases, the buyer relies heavily on the seller’s in-house legal team for conducting due diligence, to the extent that the relevant due diligence required in an M&A transaction is performed with not enough attention being paid towards the material disclosed for the due diligence, resulting in poorly drafted due diligence reports. With such report the insurer may not be able to carry out proper underwriting to assess the potential risk in the transaction. In such cases, the insurer, lacking accurate information from a poorly drafted due diligence or red flag report, faces challenges in accurately assessing the risks associated with the transaction. This results in insurer either denying its capacity for the proposed risk or quoting significantly higher premiums. Also, a poorly drafted due diligence report may cause the insurer to assess the transaction as having lower risk for which a lower premium could have been quoted. However, when the claim arises, the actual risks and liabilities becomes apparent, potentially giving rise to disputed claim. Therefore, the requirement to carry out accurate and adequate due diligence of the transaction becomes apparent and imminent to avoid any issues in the event of claim under the W & I Insurance or otherwise.
It is crucial for buyers to seek aid with legal counsel in conducting such due diligence as relying on a seller’s in-house legal team may result in inaccuracies. The external legal counsels’ involvement in identifying the red flags in the transaction and in carrying out due diligence process does play a significant role in aiding the insurers to underwrite the risk accurately and draft W&I policies for the potential insured.
Apart from the indemnity to the financial losses suffered following the breach of the warranties and indemnities, there are various other reasons for which W & I Insurance could be sought. These include:
Additional layer of security – Due diligence is carried out in any given M&A transaction. However, with the W&I Insurance, it provides an additional layer of protection. Also, the insurer of the W & I Insurance may also conduct a further due diligence which could uncover additional risk or issues which need to be addressed in the SPA and such other transaction documents.
Transfer of risk - W&I Insurance has the potential to eliminate deal-breaking risks from the transaction by transferring the majority of that risk from the involved parties to the W&I insurer.
Competitive offer process: When a prospective buyer has W&I insurance, their offer can become more appealing to a seller because it reduces the seller's exposure to potential warranty or indemnity claims.
Although W&I insurance has been commonly practiced in Europe and North America for over a decade, it has a strong potential for GCC and especially for the UAE market. According to an EY report, for the year 2022 the UAE has been at the forefront of the MENA region, with 155 deals signed worth US$17.2b. This was followed by Egypt with 99 deals worth US$3.9b, the Kingdom of Saudi Arabia with 58 deals worth US$3.4b, Morocco with 22 deals worth US$1.9b and Oman, where 10 deals have been inked with a total value of US$0.7b. The MENA region witnessed a 42% increase in the total value of M&A deals in Q1 2023 compared to the same period last year. Overall, the first quarter of the year saw 165 deals amounting to US$25.8b. For Q1 2023, UAE has recorded highest deal activity in terms of volume and value registering 42 deals worth US$2.0b. KSA, Kuwait, Egypt and Oman followed with deal values of US$1.7b, US$1.3b, US$0.6b, and US$0.2b, respectively.
The thriving business and economic environment in the GCC market continue to be an attraction for an endless list of international investors and companies, particularly in the field of mergers and acquisitions transaction. With uncertainty and risk of financial loss being part of M&A transaction, the W&I Insurance plays a pivotal role. It provides indemnification to the insured party against financial losses resulting from breaches of the tax covenant, seller's warranties, and representations outlined in the SPA.
While W&I Insurance may not be widely prevalent in the GCC region currently, the exponential growth of business activities indicates its increasing significance. As the GCC market continues to expand and integrate with the global economy, W&I Insurance has the potential to transition from being viewed as a luxury to becoming a necessity in the coming years. To keep pace with the relentless expansion of the international market within the region, W&I Insurance is likely to become a requirement, providing vital protection and mitigating risks for businesses operating in the GCC.
For further information,please contact Anand Singh.
Published in August 2023
