Transaction Insurance in Belgian M&A practice
Those with experience of negotiating share purchase agreements will know that the negotiation of representations and warranties and specific indemnities and of the related indemnification arrangements, is a time-consuming, yet often crucial part of those negotiations.
One of the aids for reaching an agreement on these issues, is the use of Warranty and Indemnity Insurance or “Specific Risks Insurance" (both often referred to as 'Transaction Insurance'). Although not (yet) commonly used in Belgian M&A practice, it is often used in other European countries (such as the United Kingdom but also in the Netherlands, Germany, Sweden) and is therefore likely to become an increasingly important element in the Belgian M&A practice as well.
Transaction Insurance: main features
Transaction Insurance may be described as coverage against losses that could arise from breaches of the representations and warranties (“Warranty and Indemnity Insurance”), and sometimes certain specific indemnities (“Specific Risks Insurance”), contained in a sale and purchase agreement.
In general, two types of Transaction Insurance exist:
- Seller-side policy: insures the seller for the loss resulting from claims brought against it by the purchaser as a result of a breach of the representations and warranties (or certain specific indemnities).
- Buyer-side policy: covers the purchaser (or the target company) for the loss resulting from breaches of the representations and warranties and/or specific indemnities. Buyer-side policies are predominantly used in M&A transactions.
Although this type of policy is typically « tailor made », some general insurance features will apply to Transaction Insurances, such as:
- The insured will have to pay a premium. Although this will vary on a case by case basis, (depending, amongst other things, on the risks to be covered, the (tipping) retention, the remaining liability for the seller under the sale and purchase agreement, …), the premiums for this type of insurance usually vary between 1% and 1.5% of the limit of the amount insured.
- The insurance policies will also provide for a “retention”, (or « deductible »,or « excess »), being the amount of losses to be borne by the insured before the insurance policy can be called on. Again, the amount of the deductible will depend on specific variables, but will often be between 0.5% and 1.5% of the total value of the transaction (equity value).
- The insurance policy will typically contain a number of exclusions (matters which are not covered by the insurance). This will depend on the negotiation of the insurance policy but typical exclusions in “Warranty and Indemnity Insurance” policies include : all disclosed matters, knowledge of the insured, fraud on the part of the insured, criminal fines, forward looking warranties and transfer pricing warranties. The exclusion of all disclosed matters, of course, significantly reduces the scope of the coverage. However, in these cases, requesting coverage for the disclosed issues through Specific Risk Insurances is negotiable.
Transaction Insurance as an M&A structuring/ negotiating tool
As shown by its increasing use in European M&A practice, Transaction Insurance can be an interesting tool in structuring and negotiating M&A transactions.
For sellers, Transaction Insurance allows them to (significantly) reduce their contingent liabilities under a sale and purchase agreement. An effective insurance policy may even allow a « clean exit » for a seller. This can be particularly interesting for private equity funds or closed-end real estate investment funds (who wish to distribute the proceeds of a sale without having to retain part of the purchase price against potential claims by the purchaser) or sellers who require (the entire amount of) the proceeds to pay back existing debts.
Purchasers may also benefit from Transaction Insurance, as it may enable them to increase the level and duration of the compensation terms as compared to those under a straight sale and purchase agreement. In certain cases, it may also protect them against potential sellers’ solvability issues. Furthermore, in private auction processes, the use of Transaction Insurance may distinguish a bid from competing bids, as an effective insurance policy will enable the bidder to seek less indemnification from the seller under the sale and purchase agreement.
The effectiveness of Transaction Insurance will, to a large extent, be determined by the terms and conditions of the insurance policy itself, and more specifically by the scope of its cover. In order for it to represent real added value, the main risks will need to be covered by the policy and should not fall within the excluded risks. It is important to note in this respect that the increased competition between Transaction Insurance underwriters has not only resulted in a pressure on premiums but also in a greater willingness of underwriters to underwrite insurance for specific risks discovered during due diligence.
Transaction Insurance: impact on deal process
The use of Transaction Insurance will have an impact on the negotiation process itself.
The insurance company will want to make its own risk assessment (by reading due diligence reports, requesting advice from its own advisers on certain topics), which may have a (limited) impact on timing. When considering the use of Transaction Insurance, the party/parties involved should, therefore, contact the insurance brokers early on in the process and provide them with a realistic set of representations and warranties / specific indemnities for which they request coverage.
Wim Vande VeldePartner Attorney at Law
Wim Vande Velde is a local partner in the Corporate and M&A Practice Group in Belgium. He has extensive experience in national and international M&A transactions for both listed and non-listed companies, as well as in corporate restructuring.T: +32 2 743 43 96 E: firstname.lastname@example.org