During Mergers and Acquisitions (“M&A”), buyers are bearing the risks of the financial, legal and operational positions of the target entity, and normally seek warranties and indemnities from the seller’s side to manage and alleviate those risks. Should the warranty be untrue and inaccurate, and the buyer incurs financial losses and damages as a result, reimbursement is typically sought from the sellers.
As a solution, the contractual parties are calling up Warranties and Indemnities or W&Is, which attract a higher premium than traditional W&I insurance policies, as the seller is not “providing” the warranties, i.e. the parties are not going through a rigorous and time-consuming process of negotiations (including exchange and flow of information, required level of due diligence comfortable to the underwriting insurer) the warranties and the seller and/or management are deprived of preparation a fulsome or traditional disclosure schedule.
In turn, this mechanism allows the sellers to pocket the financial means from the proposed sale, on the one hand, and allocate the main risks arising therefrom, on the other hand.
SYNTHETIC WARRANTY AS A RESCUE TOOL
Under conventional W&I scenario, the warrantors (sellers) would give a robust set of title, operational and tax warranties under the SPA/STA, and the relevant agreement would establish absolute right of recourse in the event of a warranty breach. The W&I insurer would then retain a narrow right to subrogate against a warrantor (namely, the seller), essentially directly claim against.
On the contrast, synthetic warranties are standalone warranties negotiated outside of a sale and purchase agreement (whether on a business sale or a share sale) between the insured (namely, the buyers or purchasers) and the insurer (those are licensed financial institutions). Synthetic warranties are insured on a “as if” basis, in the sense that is deemed that those warranties had been given by a seller to a buyer in the ordinary way.
The synthetic concept is not new. On a smaller and more specific scale, insurers in the W&I market have been providing synthetic policy enhancements alongside their W&I insurance policies for many years. The first fully synthetic W&I policy was placed in the UK in 2018. However, fully synthetic W&I policies have been limited and largely confined to transactions involving the acquisition of relatively simple businesses, such as the acquisition of property holding SPVs or asset backed businesses.
Synthetic policy enhancements have enabled W&I policies to bridge the gap between the protections a buyer is seeking under an SPA versus those which a seller is prepared to give. Different types of W&Is are used within M&As based on peculiarities of specific transaction as follows:
PROS AND CONS OF SYNTHETIC WARRANTIES
Advantages for Buyer/Purchaser
Advantages for Seller
Cons of Synthetic W&I
HOW WE CAN HELP?
Taking into consideration the practice for W&I, where a party is considering the use of a W&I policy, it is essential to take appropriate and comprehensive advice on the most appropriate insurers to reach out and on what policy enhancements and/or tailored insurance solutions might be upstanding and effective.