15 March 2018

Taking the sting out of buying and selling businesses in Guernsey

The utilisation of warranty and indemnity insurance when buying or selling a business has become a key risk management consideration to ensure deals don't collapse, write Tony Lane and Arya Hashemi of Carey Olsen.

Buying businesses – allocation of risk

On a sale of a business, one of the key concerns for the seller will be the extent to which they remain responsible for the historic activities of the business as a result of warranties and indemnities sought by the buyer. Having done the hard work of selling their company, the seller will not wish to have sleepless nights wondering whether the buyer will ask for some of the sale proceeds to be returned.

Conversely, the buyer will wish to ensure that they are not buying a business with unidentified issues, and may try to ensure that the seller remains on the hook for certain unknown, or unknowable, matters. Even where there has been a thorough due diligence exercise, the buyer will be unsure whether there are issues that the seller has not disclosed to them.

Much of the time spent negotiating a sale is spent trying to reconcile those two opposing positions, and to reach a position where both the seller and the buyer are comfortable with the level of risk to be assumed by them. 

However, if one party is not willing to assume the level of risk that the other party expects, the deal may collapse.  

Warranty and indemnity insurance – bridging the risk gap

Increasingly, parties are turning to warranty and indemnity insurance (W&II) as a way of bridging the gap between the parties' respective expectations.

W&II has been around for more than a decade but in recent years has transformed from a specialist product to one that is common place and which can be applied in most M&A transactions.

By taking out a W&II policy, a party can assume a level of contractual risk which they would not otherwise have accepted, safe in the knowledge that the insurer will meet the cost of any liability arising from that risk.

How does W&II work?

There are two types of W&II:

  1. “Seller W&II” where a seller arranges a W&II policy: the seller will accept a traditional level of risk in relation to the warranties and indemnities and, in the event of a claim, the buyer will bring a claim against the seller in the normal way. The insurer will control the claim and meet the liability (subject to any policy excess); and
  2. “Buyer W&II” – where a buyer arranges a W&II policy: the seller's liability will be capped at a lower amount (which can be as low as £1) and, to the extent that any claim exceeds that cap, the buyer will make the claim against the insurance policy.

The vast majority of W&II policies are Buyer W&II policies.

Why use W&II?

  1. Increases the likelihood of reaching a successful sale, by overcoming some of the issues that can become insurmountable obstacles.
  2. A buyer may demand a level of liability for the warranties and indemnities that a seller is not prepared to provide – W&II could be used to bridge the negotiating gap. If W&II is utilised, we usually see legal fees reduced as less time is involved in negotiation of the documentation.
  3. The seller is able to distribute (or spend!) the sale proceeds immediately, without having to retain an amount to cover possible claims.
  4. The buyer's ability to recover any losses is not dependent upon the seller being able to meet its financial obligations under the contract.

How much does W&II cost?

Typically, premiums are around 1% of the amount of cover.

Previously, W&II was not cost effective for smaller deals as insurers often required a minimum premium of around £100,000. However, more recently we have acted on transactions with premiums as low as £20,000 (providing warranty liability cover of £2,000,000).

How to find out more

Our specialist M&A team, led by partner Tony Lane, advise on all aspects of mergers and acquisitions, both with respect to transactions locally and globally, and routinely advise on transactions involving W&II.

 

An original version of this article was published in En Voyage (Issue 9), March 2018.

© Carey Olsen 2018.