Company & Commercial
Important considerations in M&A Transactions: Warranty and Indemnity Insurance
When it comes to selling a business the seller will usually be required to provide warranties to the buyer.
A warranty is a statement of fact relating to the target business. During the warranty period (usually 1 to 2 years following completion) the buyer will be able to rely on these statements of fact to bring a contractual claim if there is a breach of these warranties by the seller.
A seller can usually protect themselves by making disclosures against the warranties. This is where the seller tells the buyer why a certain warranty will be untrue when they provide that warranty so that the buyer is aware and can no longer bring a claim for breach.
An indemnity is potentially even more severe, an indemnity is a promise from a seller to reimburse pound for pound the buyer in the event that the buyer suffers losses from a pre-identified set of circumstances, such as a legal dispute.
Warranty and Indemnity Insurance
A seller who has been well advised and has been through the due diligence process and when making disclosures should be protected from a potential warranty claim. However, when giving warranties there is always the risk that something has been missed in disclosure. In addition sometimes a buyer may insist on an indemnity which could leave the seller exposed to a significant financial risk. Therefore, the opportunity to insure against the worst case scenario can be attractive.
The benefits to a seller is that it allows the seller a clean break on completion without the risk that they later become liable for a warranty or indemnity claim. Furthermore, it means that they do not need to worry about holding back some money to deal with potential claims.
For the Buyer the benefit is that they can maintain a good relationship with the seller and still being able to recover losses from the insurer. Further, if the buyer is concerned about the value of the warranties being given then they can obtain insurance to provide comfort.
Timing and Cost
If you are considering obtaining such insurance, the insurer’s lawyers will need time to conduct their own due diligence and review the sale agreement so it can take a few weeks to agree a policy.
There will usually be an excess payable. Other than this the premium will be paid as a one-off payment on completion when the policy is taken out. The cost will be dependant on the nature of the policy required and the percentage of the purchase price covered by the policy.
“It will be important for both a buyer and a seller to weigh up the cost of the obtaining a policy with the risk of needing to rely on the policy. If the business or company being sold is clean and the risk of a warranty claim is low then it will likely not be worth obtaining the policy.
If you are considering a sale of your shares or business we will be happy to assist. For further advice and assistance please contact our Commercial Team who will be able to talk you through the process.”