Australia: Mind The Gap

Last Updated: 31 October 2017
Article by Justin Gross

Warranty and indemnity insurance (W&I) is an insurance product that is tailored to protect either the buyer or a seller in an M&A transaction from the financial loss that arises from a breach of representations and warranties given by a seller in a sale and purchase agreement (SPA).

Whilst a W&I policy is usually tailored to be as back-to-back with the SPA as possible, the W&I policy is flexible and provides a buyer the ability to improve their recourse in respect of a SPA, for instance by extending claim time periods and/or simplifying recourse to one point (the insurer) when there are a number of sellers.

However, there are going to be some gaps in coverage between the W&I policy and the SPA terms. We see this on many deals and on a recent W&I policy that we negotiated for a hospitality asset we were reminded of this again.

The existence of coverage gaps is problematic for all contracting parties and the utility of a W&I policy will be eroded. From the buyer's perspective, where the parties have agreed that the W&I policy is the buyer's sole recourse, any coverage gap will be a buyer cost. From a seller's perspective, a coverage gap compromises any clean exit they desired.

We set out below some of more common coverage gaps that we see.

Inherent differences

W&I insurers will not generally provide cover for the following:

  • Known matters – Fundamental to any insurance contract is the insured's duty to disclose what they know that is relevant to the risks they seek coverage for.
  • Specific indemnities (for known issues) – Specific insurance products are available to deal with such matters (eg tax indemnity, litigation and environmental).
  • Fraud and deliberate non-disclosure – Seller fraud will usually be covered in a buyer's W&I policy.
  • Forecasts, forward-looking statements, projections and estimates – Warranties are factual statements around what has occurred. Insurers are unwilling to cover a warranty to the extent it relates to future matters.
  • Warranties drafted too broadly – Each warranty must clearly articulate the subject matter, and insurers may apply an interpretation to narrow the warranty for policy purposes.
  • Covenants, undertakings or performance obligations – An obligation in the SPA is not an insurable risk.
  • Tax "avoidance" – This is never insurable.
  • Uninsurable fines and penalties – Some countries prohibit insurance for certain criminal and like conduct.
  • Purchase price adjustments – The adjustment mechanisms around completion accounts are not insurable.

Some insurers will also not cover other specific matters including:

  • Undiligenced transfer pricing risks – Where a party has not conducted sufficient or any due diligence on the target.
  • Consequential loss (with some exceptions) – It is usual for SPAs to exclude these types of loss, and so a W&I policy will too.
  • Collectability of accounts receivable – Treated like a future matter.
  • Pension underfunding – Insurers will not underwrite the target's employee pension plans.

Specific differences

The specifics of the deal may also give rise to differences leading to coverage gaps. These arise in a number of ways, and we focus on a few common types below.

Tipping retentions

A typical SPA includes an aggregate claims threshold (or "claims basket") which must be reached before the seller is liable for loss. Usually the seller is only liable for loss in excess of that claims threshold, but SPAs can provide that once the aggregate claims threshold is reached, the seller is liable for the full amount of loss suffered and not just the amount in excess of the claims threshold.

A similar process can happen in the context of a W&I policy. For example, say a W&I policy has a fixed retention of $100 and the insured claims covered losses totalling $120, then the insurer will pay $20 (being the amount of loss in excess of the $100 retention) and the insured bears the first $100 (as a deductible). If in the same scenario the retention was a fully tipping retention, then the insurer will pay the full $120.

If the W&I policy does not mirror the SPA this then there will be an unrecoverable amount that an insured buyer must bear. Practice varies between insurers.

Coverage between signing and completion

A typical W&I policy provides coverage for a breach of signing warranties between signing and completion, a breach of completion warranties from completion, but will not provide coverage for a breach arising between signing and completion of completion warranties ("new breaches").

Insurer practice around this type of coverage varies and will depend on a range of factors including the time frame between signing and completion (the shorter the better), a right of a seller to disclose against the completion warranties prior to completion (this is not usually a feature of Australian transactions) and the ability for an (insured) buyer to terminate the SPA prior to completion.

Closing the gap

There are actions that the parties can take that can address the coverage gaps and maximise the effectiveness of a W&I policy. These include:

  • Proper quality due diligence and proper disclosure process – Insurers expect a reasonable level of due diligence and disclosure to have occurred in relation to the M&A transaction. This is technically required by the insured's duty of disclosure and is practically required for the insurer to conduct their underwriting. The better the quality of the due diligence and the disclosure process, the better the information for the insurer to analyse and more accurately price the risk.
  • Arms length dealings and reputable professional advisers on each side – The more robust the general transaction negotiation methodology is between the parties then the more comfortable the insurer will be that the information provided is full and fair and that the warranties and indemnities the insurer is being asked to insure reflect a position that more clearly reflects the risks being assumed.
  • Warranties being properly and thoughtfully drafted – It is important to phrase warranties clearly and concisely to correctly articulate the matter they relate to and ensure they are properly statements of fact or circumstance. The better the warranties are drafted, the less likely the insurer will include exclusions in the W&I policy and the better and clearer the coverage provided.

If the above matters are not handled well, then in our experience it costs the parties time and money and maybe even kill the deal. It is clear that when insureds are looking at their W&I insurance options, they should turn to their specialist W&I insurance broker, their lawyer and/or their financial adviser. They can minimise the coverage gap and this can mean valuable results for the client – a much higher quality W&I policy and likely for a lower premium.

So, get in touch with your W&I experts....and mind the gap.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions