Warranty and Indemnity insurance

Following the established trend in the UK market, where at present practically all deals are closed with a Warranty & Indemnity insurance, this product has significantly increased in popularity in the Spanish M&A market over the last five years.

Thus, in our experience at Ashurst Madrid, W&I insurance has been used in almost 40 per cent of the M&A transactions in which we have provided advice in Spain during the last year (when five years ago it barely represented 10 per cent of the total) and their subscription has been taken into account in practically all the transactions, and it is a particularly relevant tool in complex deals.

Of course this is not a phenomenon that affects only the UK or Spain: over 30 per cent of all private M&A transactions in Europe which Ashurst was involved in were executed with W&I.

Reasons for the growth in use of W&I insurance in Spain

In our experience, some of the main reasons for the increase in popularity of W&I insurance in the Spanish M&A market are the following:

• For the last few years, we have lived in a pro-seller market, where the enormous liquidity available to private equity funds and the relatively few investment opportunities have increased the negotiation power of sellers, who are quite concerned about having a “clean exit”.
• Insurers have greatly improved this product in terms of:
  
  • Coverage:
    
    • exclusions are limited and already known in the industry. Insurers no longer compete only on price, but also on coverage. Therefore, they are now offering separate tailor-made policies to cover specific risks which were not considered insurable in the past (transfer pricing, environmental and disputes); and
    • improved coverage limits with respect to an ordinary SPA regime, both in terms of time (e.g. usual time limitation of 18 months for general warranties in SPAs vs 2-3 years under a W&I insurance) and liability cap (around 15-30 per cent of the price in SPAs vs 10-30 per cent of enterprise value under a W&I insurance).
  • Process and timing: the policy negotiation process with insurers (where specialist brokers have been of great help) has been significantly speeded up, with an average underwriting time of three weeks from first contact and simpler policies.
  • Price: around 2-3 per cent of the liability limit and we are seeing a consistent downward trend.

Not only have insurers significantly improved the coverage of W&I policies, their price and the process for their execution, but the large number of claims paid by the insurers is also notable (around 84 per cent of claims under W&I policies have been paid during the last year as informed by Howden Iberia (broker).

The section of the SPA that entails more discussions and disagreements and takes up the most time during negotiations is that relating to the liability regime of the sellers (if it is the case that the seller is willing to face the uncertainty of being liable for 18-24 months for the granting of general representations & warranties on the situation of its former company or business). In this regard, the improved commercial attractiveness of W&I insurance in Spain and the faster underwriting process have made it possible not only to speed up and unblock negotiations, but also to ensure that the purchaser obtains a broader coverage of risks that it would not otherwise have obtained (e.g. in terms of length of coverage).

Recent developments

The greater use of W&I insurance in M&A deals in Spain, as well as in the UK, over the last few years has led to a more sophisticated product, which is now capable of being adapted with a certain degree of flexibility to the particularities of each transaction.

In this regard, we have seen the following developments and trends in the W&I policy market in the last two years:

• Some insurers are starting to look favourably on new bridge insurance for very short interim periods. New bridge insurance will completely cover the gap between signing and closing.
• Some previously rejected policy enhancements are slowly becoming popular (although they usually involve increases in the premium). We are referring here to the exclusion of the seller’s knowledge qualifier and no disclosure of the due diligence reports and/or virtual data rooms:
  
  • As for the first, if a blanket knowledge qualifier is applied to the warranties under the SPA, it is possible to remove this in the W&I policy. This is typically subject to an additional premium of 10-20 per cent.
  • As regards no disclosure of the due diligence reports and/or virtual data room, certain insurers may be willing to offer one (but not both) as an enhancement of the policy. Non-disclosure of the virtual data room is probably preferable, but as yet is only offered in simple deals and subject to significant additional premiums.
  • Premiums are, in general terms, decreasing (particularly on small deals, e.g. less than a billion euros) given the strong competition in the sector and that international insurance players have gained advanced knowledge of the Spanish market and are now willing to offer broader coverage of risks at a reasonable cost.
  • Increased appetite for synthetic R&Ws (i.e. those directly granted by the insurer), especially in deals involving a seller that is a public administration.

• Hard staple vs soft staple:
  
  • In large deals (over a billion euros), the hard staple is gaining ground. With a hard staple, the seller approaches the insurance market in the initial phase of the deal. The selected insurer will proceed on the basis of the virtual data room (or vendor due diligence) and will produce an advanced draft of the W&I policy form, which will be disclosed to bidders. Normally, the draft will be negotiated by the insurer with the preferred bidder only, but we have seen highly competitive processes in which insurers agreed to engage with multiple bidders.
  • Given that hard staple is time-consuming for the seller and involves a generous amount of resources, some sellers opt for a softer method of stapling. In the soft staple, the seller provides bidders with a broker report drafted after an initial survey of the insurance market. Under this scenario, access to the broker and insurance companies is given only when exclusivity is granted to a preferred bidder and the underwriting will proceed on the basis of the buyer’s due diligence reports.

• In relation to the Covid-19 exclusion, after an initial phase in which insurers considered it essential, it has become relatively easy to eliminate such general exclusion, even for sensitive business, provided that due diligence is thorough on certain key issues (e.g. employment matters).

Role of the legal adviser

It might seem that, in a scenario in which the most critical part of a SPA is covered by taking out a W&I insurance policy, the role of lawyers would be less relevant. However, and despite the intermediation work of brokers, legal advice is essential in terms of the analysis and explanation to the various parties involved (buyer, seller and insurer) of the legal risks of the transaction and the articulation of the coverage of the same between the W&I policy and the SPA (in such a way that, jointly, through the negotiation and amendment of the wording of the W&I policy, and the regulation included in the SPA, the objective of risk coverage that is sought is reached).

Authors: Jorge Vazquez, Partner; Francisco Vazquez Oteo, Counsel