W&I insurance plays an important role in M&A transactions and is a budding insurance market. The M&A market is currently experiencing an increase in limited or no recourse deals, inevitably driven by sellers desiring 'clean exits'. This, in turn, has resulted in the growth of buyers procuring buy-side W&I insurance policies.
M&A auction sales are often used as an effective mechanism for eliciting the most competitive bids on the best possible terms. Among the terms up for negotiation are the warranties and indemnities provided by the seller under the sale and purchase agreement (SPA). In auction sales, we are seeing sellers actively requiring buyers to take out buy-side W&I insurance policies. Typically, during an auction sale process, sellers will initiate the procurement process for the W&I insurance policy which the successful bidder will be required to take out.
The sell-buy 'flip' process
Initially, a broker will be engaged by the seller to assist with the procurement of the W&I insurance, as well as to advise on the appropriate insurance structure.
The broker will prepare a submission document to go to the market which will include details such as a draft SPA, timing and coverage requirements and information in relation to the advisers to the seller. W&I insurers who have an appetite for such risk will then issue non-binding indicative terms, including preliminary pricing and coverage positions. These terms will be collated from various insurers by the broker, for review by the seller.
Following the seller's review, the broker will be instructed by the seller to engage a particular insurer. The broker will then draft a memo for inclusion in a virtual 'data room', including information such as the process, cost and timing involved in obtaining the W&I insurance policy. Simultaneously, the insurer will be given access to the virtual data room and begin reviewing its contents.
Once the successful bidder is selected by the seller, the W&I insurance procurement process is then 'flipped' to the buyer. The broker's engagement with the seller ceases at this point, and engagement begins with the buyer. The broker should now be acting on behalf of the buyer to finalise the procurement of the insurance policy.
Detail and pricing
Although insurers will be able to provide initial pricing indications and coverage information before the successful bidder is chosen, the underwriting process will only be completed once the insurer has been able to review documents such as the buyer's due diligence reports and the final SPA.
This presents an issue in relation to the basis on which the insurers provide their initial indicative quotes. For example, the preliminary drafts of the SPA for the auction process are likely to contain warranties that are seller biased, and will often be subject to change once the successful bidder has been chosen. It is therefore possible that, by the time negotiations are complete, the final SPA might look materially different to that on which the insurer provided its indicative quote. In this situation the insurer may increase its pricing, include new exclusions or only provide part cover for certain warranties and indemnities.
Insurance brokers will need to ensure that parties to a transaction are made aware of the fact that the ultimate cost or cover of the W&I insurance will not be finalised until the transaction documentation is agreed, the insurer has reviewed the buyer's due diligence materials and carried out its underwriting process, and the insurer formally consents to the risk.
Should brokers be conscious of conflicts of interest?
Among the challenges that affect these sell-buy 'flips' are the concurrent fiduciary duties owed by the broker to both the bidder and the seller once the flip has taken place. An insurance broker owes a fiduciary duty to its client. This means that the broker must:
- not put its interests before the interests of its client;
- not make a secret profit;
- always act in its client's best interest (which may cause problems when the interests of two or more clients compete); and
- ensure client confidentiality.
In a sell-buy flip, the broker who was initially engaged by the seller will subsequently be engaged by the buyer in relation to the same transaction. The broker will keep the knowledge base it developed during the initial engagement with the seller. Any data on the broker's file at the time of the switch will then become the data of the buyer in the transaction: something which a broker ought to make the seller aware of, as part of its fiduciary obligations to the seller. Once the flip occurs, the broker will also owe a fiduciary obligation to the buyer and concerns can arise as to what information the broker is permitted to share with the buyer. The broker may be conflicted in that it must ensure the seller's confidentiality, but it must also act in the buyer's best interests.
An insurance broker engaged to procure a W&I insurance policy undoubtedly has a financial interest in seeing the transaction complete. At the same time, it must be mindful of the fiduciary obligations owed to both the seller and the buyer, and must not put itself in a position where either its own interests conflict with those of its principals, or the interests of the buyer and the seller compete so that the broker is not able to act in the best interests of both. Brokers will have to consider their common law obligations, the terms of any terms of business agreements (TOBAs) and the management of their regulatory requirements.
An additional concern is that under the 2015 Insurance Act an insured, in this case the buyer, is under a duty of 'fair presentation' to the insurer. This duty includes a requirement on the buyer to disclose every material circumstance which it knows or ought to know. For the purposes of this requirement, the broker's knowledge is imputed to the buyer. This means that confidential information provided by the seller to the broker will be deemed to be both within the buyer's knowledge, and disclosable to the insurer.
Issues can arise here as to whether the broker is able to disclose this information to the buyers and insurers for the purpose of the buyer meeting its Insurance Act obligations. Furthermore, compliance issues with the Insurance Act arise for the buyer if it does not disclose the information, and insurers may be afforded the various remedies under the legislation for a breach of the duty of fair presentation by the buyer.
An insurance broker is obliged under the regulatory regime to identify and manage conflicts of interest. A broker will also be concerned about mitigating potential exposures to claims for breaches of fiduciary duty. Therefore, a broker may choose to manage its potential conflicts through clear communication with the parties at the outset of the engagement. For example, the broker can formally disclose the existence of the conflicts to the buyer and the seller and have them both consent to the broker's involvement on terms acceptable to both the buyer and the seller. This can be achieved in its terms of engagement document with both of these parties.
The broker could also consider the use of information barriers within its organisation. However, unlike disclosure and acceptance of a conflict by the relevant principals, information barriers do not remove the conflict as a matter of law; they are merely a tool to manage conflicts. Brokers will need to consider the efficacy of information barriers in light of case law and whether such arrangements are sufficient and appropriate to meet their regulatory and legal obligations.
If the conflict management by the broker is not to the buyer's satisfaction, it does have the option to require its broker to conduct a fresh review of the market. However, the seller may have made it a condition of the deal that the W&I insurance must be procured from the insurer it engaged with before the flip.
Jonathan Cavill is an insurance law expert at Pinsent Masons, the law firm behind Out-Law.com.