When to take out manifestation and warranty insurance in an M&A transaction

It is becoming increasingly common in M&A transactions between Spanish companies to take out a manifest and warranty insurance policy, also known as W&I Insurance in English-speaking countries, where these policies have always been more popular.

Its advantage is that this type of insurance allows the transfer to the insurance company of the risk derived from the obligation to indemnify the buyer for the possible lack of truthfulness and accuracy of the representations and guarantees given by the seller.

Let’s look at it in detail.

How responsibilities in mergers and acquisitions are assigned

From the date on which the actual transfer takes place, it is most common in an M&A transaction for the buyer to assume all the business risks inherent in the acquired business.

For his part, the seller is liable if he breaches agreed obligations, such as the non-competition obligation. Also for the lack of truthfulness and accuracy of the representations and guarantees that he has given in favour of the buyer in the contract of sale.

What is manifestation and warranty insurance

In contrast to this default allocation of responsibilities that is established by default in any merger or acquisition, manifestation and warranty insurance introduces a solvent third party, the insurance company, which assumes part of the risk.

The most common type of W&I Insurance policy is one in which the insurer assumes the risk arising from the seller’s obligation to indemnify the buyer for the lack of truthfulness and accuracy of the representations and warranties given by the seller.

What exactly are these representations and warranties? They are a set of statements concerning certain circumstances relating to the seller himself, the shares/shares being transferred and the business conducted by the company being transferred.

Transactions in which M&A insurance is frequently used

The first thing to do is to anticipate the need to take out an insurance policy for demonstrations and guarantees. In this way, we will be able to integrate it as another element within the negotiation. These are three of the cases in which it may be advisable to take out a policy of this nature:

On the seller’s side, when the seller is a private equity fund looking for a clean exit and does not want to assume any liability for past contingencies.
On the buyer’s side, in competitive processes, where several aspiring buyers submit their purchase proposals to the same seller. The introduction of a manifestation and warranty insurance in the offer can be an important advantage that can tip the balance in favour of one of the potential purchasers.
In the formation of joint ventures, this type of insurance allows the new partners to neutralise the emergence of potential conflicts.

How to take out manifestation insurance and guarantees

Any insurer will require a thorough understanding of the transaction to be covered. To do this, it is best to first carry out a thorough due diligence on the business being bought and sold. In the absence of this step, the insurance company will require at least an analysis of the areas about which it does not have sufficient knowledge. Otherwise, it will exclude these areas from the policy coverage or may even refuse to underwrite the policy.

On the other hand, it should be borne in mind that drafting an insurance policy of representations and warranties requires a precise definition of certain concepts. For example: the concept of damage, the quantitative and qualitative thresholds of limitation of liability, the claims procedure, etc. To this end, it is essential to have legal advice from a legal expert in M&A transactions involving representation and warranty insurance.

By Álvaro Mendiola