Previous articles in this series have considered issues which arise before the warranty and Indemnity (W&I) policy process begins in earnest such as the strategic use of W&I insurance and the insurance due diligence process. When it comes to initiating the W&I policy process however, parties to a transaction have a number of options. The most common of these is that a buyer will initiate the process with the aim of implementing a buy-side W&I policy. However, a seller can also initiate the W&I policy process, either with a view of putting in place a sell-side policy or to testing the market for the available cover under a buy-side policy and having the buyer engage W&I insurance on those terms.
W&I buy-side policies and sell-side policies
The overwhelming majority of W&I policy placements are initiated by the buyer. A W&I policy taken out by the seller is less common (although in recent years there has been an increase in seller-initiated processes from approximately 2% of policies placed by WTW in 2020 to 5% thus far in 2024) and comes about in scenarios where there are individual sellers who might take comfort in being the named insured and in having sole influence over the scope of policy coverage. Sell-side policies work well for family businesses and founder-owners who disproportionately take this route, at times not engaging with W&I insurance until fairly late in the transaction once the deal is in motion and sometimes even after the disposal has occurred.
Hard or soft stapling?
Even where the buyer will ultimately be the named insured, it is often the seller that initiates the W&I policy process with a view to handing the process to the buyer at a later stage – an approach known as "stapling". A seller-initiated staple can be done in one of two ways, "hard" or "soft". A soft staple being where the seller markets the transaction to insurers and provides the buyer with the market indications after which the buyer takes the W&I insurance process forward at their discretion.
Most commonly we see the hard staple adopted in those larger or more complex transactions in which vendor due diligence has been undertaken.
In a competitive process however, a hard stapled approach is often the chosen method for sellers as it will provide additional control of the W&I insurance workstream to the seller because the seller selects an insurer and underwriting begins on the sell-side before passing an advanced policy to the buyer to complete the process. Most commonly we see the hard staple adopted in those larger or more complex transactions in which vendor due diligence has been undertaken. Hard staples often allow sellers to run an organized process and to retain control of the W&I policy's progress for longer, allowing them to have their interests reflected in earlier drafts and to get an initial view of coverage. Where time is of the essence, a hard staple allows the seller to retain control of the timings for the W&I insurance workstream. Finally, a level playing field is created for all bidders as each bidder will be presented with an identical set of warranties which are backed by W&I insurance which has already been partially negotiated.
Market conditions and their influence on hard staples in M&A deals
Depending on the mood of the M&A market, the commercial viability of the hard staple may vary. In a more dynamic M&A market where assets have the serious attention of multiple bidders, sellers often feel empowered to drive hard staples, allowing them to control the insurance process and to have some input in the outcome of coverage. In slower markets, however, buyers will be in a stronger position and market sentiment may dissuade sellers from mandating too many requirements with respect to W&I insurance. In this situation, sellers have to consider the relationship between the time and resources required to run a hard staple and the prospect that buyers may be less committed to processes and less prepared with their finances. As such, questions of balancing the competing interests and power relations in a deal will often dictate the type of staple that is engaged and issues such as buyer sensitivity, process cohesion and the maintenance of competitive tensions are key aspects that drive the decision.
Further considerations
- There are certain sensitivities to consider on a hard staple particularly, in the current environment where transaction parties can be more sensitive to costs. For example, on the insurer side, as markets become more active, appetite and available resources for running multiple underwriting trees tend to decline. WTW has seen market conditions where an insurer is unwilling or unable to allocate more than two underwriters to a single deal – having implications for a seller that wants to front-load the W&I coverage of multiple bidders before they select a buyer. Conversely, buyers may not be willing to take on insurer mandated break fees in a multi-tree W&I insurance process that is attached to an auction.
- Another consideration relevant in harder markets is that hard stapling will allow a seller to lock-in an insurer's risk capital. In a busy market, insurers will sometimes reach their annual maximum deployable capacity before the end of the year. WTW have seen several instances in the past where deals have had to be pushed into the following year as a result of insurance market capital being expended in the previous year. This dilemma may be avoided in a hard staple scenario as insurers reserve capacity in advance of their going on risk at inception.
How can WTW help?
WTW's Transactional Risks team is made up of qualified lawyers and tax and accountancy practitioners who appreciate the transactional complexities and commercial realities clients face. As such, we are well positioned to guide clients through the process of insuring transactions and ensuring that the policy procured meets all the needs of the insured and addresses the nuances of the transaction; as every transaction is unique, every transaction requires a bespoke solution. We take time to properly understand each client and their position so that we can obtain the insurance fit for them. Clients have plenty to consider when undertaking transactions and therefore the WTW team seek to make the insurance process as straight forward as possible, utilizing our wealth of industry experience and leveraging trusted industry relations to negotiate purpose-built policies on your behalf.
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.