Warranty & Indemnity insurance – how it is used in Corporate Real Estate deals

Warranty & Indemnity insurance (W&I) is now the default option in Corporate Real Estate transactions for sellers wishing to protect themselves against liability under the warranties and tax covenant given under sale agreements. This article explains what W&I is, how and why it is used and examines some key issues which typically arise.

What is W&I and how does it work?

On the sale of a corporate entity such as a private limited company or a limited liability partnership, the seller will typically provide the buyer with a range of contractual promises, or warranties, regarding the company and its activities.  It will usually also offer a tax covenant or indemnity, which will provide a pound for pound reimbursement to the buyer in respect of any tax liability that the buyer or the target company incurs in relation to any tax liabilities for the period prior to the completion of the sale.

W&I insurance is a type of transactional insurance policy that covers these contractual liabilities, enabling the buyer (or sometimes seller) to bring a warranty or tax covenant claim against the insurer, rather than the seller becoming primarily liable. W&I has been widely used in corporate real estate transactions over the past fifteen-plus years, and as such the market is mature, with property-owning SPVs being a well-understood and straightforward asset-type.  There is usually a wide choice of insurers offering coverage which keeps pricing competitive.

Insurers may also be able to provide specific property title insurance cover as part of (or as a bolt-on) to the W&I policy.

Who takes out the policy?

Typically the W&I policy will be taken out by the buyer (a Buy-side Policy) meaning that it can claim directly under the policy as the insured party, allowing for the seller’s liability under the transaction documentation to be limited to a nominal figure (usually £1), with any claim by the buyer for a warranty or tax covenant breach being against the insurer. 

Rarely seen, but not extinct, is for sellers to insure their own warranty and indemnity liability through a back-to-back arrangement (Sell-side Policy) whereby the seller can seek to recover claimed amounts from the insurer.  In this case the seller remains primarily liable in full for all warranty and indemnity claims in the transaction documentation.  This is unusual in transactions as a buy-side policy is generally preferable for sellers as it more effectively limits a seller’s liability via the £1 cap, and means that buyers have a reliable financial covenant backing any potential claims.

The Buy-side Policy, with a cleaner exit for the seller, does not always need to be initiated by the buyer. A seller can commence the process with it “flipping” at the appropriate point in the process to the buyer to take forward. The requirement that a buyer take out W&I insurance may be included in a seller-draft SPA contained in a data room as part of a competitive auction process,

Buyers will engage a specialist transactional insurance broker to source the most commercially advantageous policy and to lead the process with the insurer.  Brokers’ fees will generally be paid by the insurer rather than by the insured.

How is the policy premium paid?

The premium to be paid to the insurer is for the buyer’s account, but often it is agreed commercially that the cost be passed on to the seller by deducting the premium from the purchase price. Other options are available e.g. the seller is responsible for a portion of the premium, either by percentage or a fixed sum. In that way, if the Buyer wants to add various enhancements to the W&I insurance policy, which each come at a cost, it can do so, but it alone pays for those. It is considered that the premium payable is a worthwhile deal cost for the deal certainty and de-risking that W&I  Insurance brings.

Why use W&I Insurance?

For sellers:

The reallocation and transfer of risk to a third party (i.e. the insurer) makes the warranty negotiation process easier whilst providing comfort to the buyer. Combined, this increases deal certainty.

It allows for a clean exit and for sale proceeds to be optimised with no need for any no escrow of sale proceeds.

For buyers:

The ability to apply better terms, i.e. in the W&I insurance policy it is possible to get coverage for up to three years from closing for general warranties even though in the SPA that period is 18 months.

With claims being made confidentially, usually between the buyer and insurer, the reputations of the buyer and seller are protected.

By claiming against an insurer rather than, for example, a management team or JV partner, reputations are preserved.

Critically, recourse is against a creditworthy insurer, rather than having to worry about whether the seller will still have the means to respond to any successful claim long after completion has happened.

Is W&I right for your transaction?

For sellers:

The key driver as to whether it is worth a seller requiring W&I to be used on a transaction is whether commercially it represents good value in the context of the overall deal value.  For example, on a £1m transaction, a policy costing the seller £120,000 is unlikely to make economic sense. As such it tends to be used on mid to high-value transactions where economically the cost/benefit analysis is more favourable.

The seller and buyer will need to agree the amount of cover that will be provided under the policy – as this links to premium levels, the seller will not be prepared to pay more for more coverage than it considers necessary (and this will very rarely be 100% coverage).

For buyers:

In general, buyers are often happy to put W&I in place, as it provides reliable way to derisk an acquisition, and can sometimes provide a stronger financial covenant than the seller can offer.  The prevalence of W&I in property transactions means that it is a familiar product amongst both the transaction parties and their advisers, and can be woven into a transaction seamlessly.

A key point for buyers is to be clear as to the extent of the policy coverage – typically there are a limited range of warranties that are excluded from cover.  These often include environmental-related warranties or warranties related to transfer pricing.  A standard W&I policy will also not usually cover known risks, so any specific issues identified through the buyer’s due diligence may need to be covered separately (e.g. through a separate indemnity for which the seller is liable in full, or through a price reduction).

There will always be an element of risk for the buyer that it is unable to bring a claim under the policy due to a policy exclusion, and then due to the £1 cap on the seller’s liability, is also unable to recover against the seller.  The market standard position is usually that the £1 cap is only disapplied in cases where the seller has acted fraudulently.

What is the process for putting W&I in place?

A typical W&I process will comprise the following steps:

1. Approach to the insurance market: a buyer will engage a broker to make an approach to the W&I market, following which the broker will draft a Non-Binding Indication (NBI) report, which will set out summary policy details and pricing for the most favourable quotes the broker has sourced. There will also be bolt-on provisions that can be selected for an additional premium.
2. Selection of insurer: the buyer will, following discussions with the broker and its other advisers, select the preferred insurer.  The buyer will need to balance premium cost against the policy limit, levels of excess, and policy coverage.
3. Due diligence: the buyer will provide its due diligence findings to the insurer, who will then review the relevant adviser reports and raise any points for clarification as underwriting questions which the buyer and its advisers will need to respond to. In parallel, the insurer will review advanced drafts of the SPA.
4. Agreeing policy terms: the insurer will produce its final policy terms for approval by the buyer.  The broker will lead on these negotiations.
5. Completion: on completion of the transaction, the policy will become binding, and the premium will become due for payment.

Key issues for transactions

Building a W&I process into a transaction means adapting the standard deal process to incorporate the above steps.  There are some key issues which in our experience need to be considered for corporate real estate transactions:

1. £1 cap: the buyer must be comfortable that, absent fraud, the seller’s total liability for warranty claims (save in the case of fraud) is capped at £1 and that there will certain warranties (e.g. environmental) that may fall outside the scope of the policy.
2. Insurer due diligence: the insurer may wish to undertake its own due diligence on certain key areas, depending on the scope of due diligence that the buyer and/or its advisers have undertaken.
3. Underwriting questions: the insurer’s underwriting questions may only arrive later in the transaction process, so sufficient time should be built into the deal timetable to deal with responding to these.
4. Cost: as mentioned above, the seller must be comfortable that the cost of the W&I premium is in proportion to the deal value.
5. Timetable: while W&I insurers are very familiar with transaction processes and can work at pace, the added complexity of W&I in a transaction can add to a deal timetable so if a transaction must be completed in an abbreviated timeframe, it may not be possible to put W&I in place. The W&I process proceeds in parallel with the deal documents being negotiated.

Conclusion and our experience

In a world where W&I is increasingly a default option for corporate-wrapped property transactions, buyers and sellers need to be able to leverage the best of what W&I can offer to make transactions easier, less risky and more viable.

Burges Salmon’s Corporate Real Estate team have in depth experience in corporate-wrapped transactions and have links with many of the leading W&I brokers.

With a team of Built Environment lawyers qualified across England, Wales, Scotland and Northern Ireland, we support clients on real estate matters across jurisdictions and project types. Our Corporate Real Estate team works closely with colleagues in construction, planning, tax, litigation, environmental and finance to provide integrated support throughout the lifecycle of real estate assets.

We have experience across many sectors including logistics, hospitality, office, residential (including build-to-rent and student accommodation), and large-scale regeneration schemes. If you would like to explore any of the topics discussed above, please contact Jonathan Cantor (Partner, Corporate and M&A) or Gregory Nash (Director, Corporate and M&A.