10 Practical Tips for Navigating the W&I Underwriting Process

Warranty and indemnity (W&I) insurance provides cover for losses arising from a breach of warranty, or a tax deed claim, in connection with a merger or acquisition (M&A) transaction. The use of W&I insurance offers significant advantages (such as allowing the seller to make a clean exit, and helping to maintain the relationship between the parties), and as such, is becoming an increasingly common feature of M&A transactions.

Introduction

This article offers 10 practical tips for parties seeking W&I insurance (Insureds) and their advisors when navigating the W&I underwriting process, which broadly comprises 3 main stages: (1) firstly, the Insured engages a W&I insurance broker to obtain insurers' indicative policy terms (also known as non-binding indications (NBIs)), (2) secondly, the chosen insurer proceeds with underwriting, including reviewing the transaction documents and due diligence reports, issuing underwriting questions for the Insured and their advisors, and attending an underwriting call with the Insured and their advisors (as needed), and (3) thirdly, the negotiation of the coverage under the W&I insurance policy. The inception of the W&I insurance policy typically coincides with the signing of the transaction documents.

Timing 

1. Engage a broker early: The W&I underwriting process (from providing information about the deal to policy inception) can take up to 2 to 3 weeks. As such, it is helpful to engage a W&I insurance broker early in the deal timeline, so that the broker can kickstart the W&I underwriting process by approaching insurers for their NBIs. Insurers usually only require the draft sale and purchase agreement (SPA) and information memorandum to provide their NBIs – due diligence reports are not necessary at this juncture. 

2. Keep NBI expiry dates in mind: Insurers' NBIs typically expire 30 days after they are issued. If there is an extension of the deal timeline, inform the broker as soon as possible so that the broker can request for extension of insurers' NBIs as appropriate. 

Due diligence

3. Carry out the appropriate level of due diligence: At minimum, insurers typically expect legal, financial and tax due diligence to be carried out by third party professional advisors. Having said that, all relevant categories of warranties requested to be covered by the W&I insurance policy should be supported by comprehensive and appropriate due diligence, and gaps in due diligence will generally lead to gaps in coverage. For example, if an Insured is acquiring a technology company and is seeking W&I cover in relation to intellectual property (IP) warranties in the SPA, then the subject matter of these IP warranties should be investigated in the due diligence process.

4. Materiality thresholds should align with W&I de minimis threshold: The materiality thresholds applied in the Insured's due diligence should match the de minimis threshold in the W&I insurance policy. This is consistent with the general principle that gaps in due diligence will lead to gaps in coverage – if the due diligence does not pick up issues below a certain amount, then the W&I insurance policy will not do so either.   

5. Internal due diligence will be closely scrutinised: Due diligence carried out by third party professional advisors is generally preferred (especially in relation to legal, financial and tax matters). While it is possible to obtain W&I insurance where due diligence has been carried out internally, insurers tend to closely scrutinise internal due diligence reports, and expect internal due diligence to be carried out by persons with the requisite subject matter expertise. 

6. Be aware that major identified issues are excluded: W&I insurance is intended to cover unknown issues arising from breach of the warranties under the SPA. As such, major identified issues in the due diligence are likely to be specifically excluded by the W&I policy. Insureds should be aware of this, and seek other protection (for example, specific indemnities under the SPA) as may be required. 

Underwriting questions

7. Tackling questions on gaps in due diligence: Insurers may ask underwriting questions in relation to gaps in due diligence, especially where the warranties in the SPA extend to matters which do not appear to have been diligenced. For example, where the warranties in the SPA apply to all subsidiaries of the target company, but the due diligence appears to cover only certain subsidiaries, the insurer may ask an underwriting question around what due diligence has been carried out on the remaining subsidiaries (and if there is none, how the Insured has gotten comfortable with the risk that warranties in relation to those remaining subsidiaries have not been breached). To the extent that there is a commercial rationale available, it is often helpful to include this in the response – in the present example, the Insured may state that the focus of their due diligence has been on material subsidiaries only, and it is not commercially pragmatic to diligence the remaining subsidiaries because they are non-operating and/or insignificant from a revenue contribution perspective.

8. Tackling questions on identified issues: While major identified issues are often excluded by the W&I insurance policy, insurers may still ask underwriting questions around them. For example, insurers may wish to understand whether certain identified issues are indicative of broader systemic issues or poor controls within the target company. When preparing responses to these questions, Insureds should consider factors such as: (i) whether the cause of the identified issue has been properly investigated and remedied, and (ii) whether the identified issue is a recurring event, or a one-off. 

9. Quantify the risk: To the extent possible, Insureds and their advisors are encouraged to quantify potential risks. Insurers may be comfortable without a specific exclusion in relation to an identified issue, if the potential liabilities arising from that issue are shown to be immaterial and/or below the de minimis threshold. 

Underwriting call

10. Insured's deal team should lead the underwriting call: Ideally, the Insured's deal team should take the lead in responding to the insurer's questions during the underwriting call, with the option to defer to the advisors on technical or specific due diligence points. This is so that the Insured can offer its commercial perspective on how it has gotten comfortable around certain issues in relation to the deal; on the other hand, advisors are often limited to responding only from an advisor's perspective, and are confined by their scope of engagement and the information available to them.    

Advisors should be prepared to supplement the Insured's responses, where appropriate. If the requested information is not on hand during the underwriting call, the Insured may follow up in writing after the call.