Warranty and indemnity insurance (W&I) has become a common feature of European transactions in recent years, amid a strong sellers’ market that has enabled vendors to offload risk to buyers. According to the most recent edition of the Latham & Watkins Private M&A Market Study, which examined transactions between July 2016 and June 2018, the proportion of transactions employing W&I has continued to increase — from 8%, 13%, and 22% of deals in the previous three editions of the survey, to 32% for the latest period surveyed. We believe M&A deal teams should be aware of changes and enhancements to W&I that will bring insurance coverage closer in line with the US market. In our view, the developments are positive for M&A bidders.
The Impact of US Buyers on European W&I Policy Terms
US buyers are very active in the European deal market, and their influence is becoming increasingly evident in W&I terms. US buyers are pushing for more US-like W&I terms on European deals, and the changes have enhanced policies. Insurers are thinking outside of the box and providing new products. We believe US M&A bidders will reap the benefits as policies begin to resemble their home market and M&A bidders from other jurisdictions will also benefit as terms become enhanced.
One recent trend that is particularly notable is the introduction of a policy enhancer combining the US and European disclosure standards, whereby the transaction documents follow the European seller-friendly standard that the entire data room is disclosed against all business warranties, whereas the W&I policy deviates from this standard and follows the US buyer-friendly standard that warranties are only qualified by the specific disclosures set out in the disclosure schedule letter. We have seen European policies beginning to feature an indemnity basis of recovery, rather than the standard contractual basis usually provided under an English law share purchase agreement. This means buyers will be able to claim for losses on a pound-for-pound basis, without having to prove the actual reduction in the value of a company caused by a specific warranty breach.
An Increase in Synthetic W&I Features
A host of “synthetic” US W&I features have crept into European policies — including extended duration for claims, disapplication of de minimis, and synthetic tax deeds. Many synthetic enhancements are routinely available, but may be sector or jurisdiction-specific. M&A bidders should raise enhancement requests with their brokers early in a process, as certain features may only be offered by specific underwriters. However, M&A bidders should be mindful that enhancements can increase the extent of due diligence required and the premium payable, while some insurers may take a more conservative approach to policy enhancements on large-cap deals.
The W&I market continues to evolve. Recent W&I trends should provide more comfort to M&A deal teams as they navigate this sellers’ market. We believe firms must keep up to speed with W&I developments and ensure they have the best coverage before they approach a potential deal.