Transaction insurance plays a key role in M&A deals by reducing risks and helping facilitate negotiations.
It is designed to cover financial losses resulting from unknown breaches in the seller’s representations and warranties, or tax indemnities, as outlined in the share or asset purchase agreements. This type of insurance is often chosen as an alternative to using escrow arrangements.
In this article, we will explore the differences between US-style representations and warranties insurance policies (R&W Policies) and European-style warranty and indemnity insurance policies (W&I Policies).
Understanding these differences is essential for US buyers to make an informed decision about whether to choose a US-style R&W Policy or a European-style W&I Policy when engaging in M&A transactions in Europe.
US buyers often opt for a US-style R&W Policy in European M&A deals. This decision can result in a more Anglo-American approach to the purchase agreement.
For instance, a US-style purchase agreement will typically focus on specific disclosure concepts, provide detailed closing conditions, and include a broader range of representations and warranties. These warranties are given as of both the signing date and the closing date.
When it comes to the scope of coverage, US-style R&W Policies tend to be more favorable to policyholders, offering fewer exclusions and a broader range of protections against breaches of representations and warranties compared to European-style W&I Policies.
It is important to note, however, that European-style W&I Policies have improved in recent years, with fewer exclusions and the possibility to agree on a specific disclosure concept for an additional premium, due to the growing competition among insurers.
One of the main differences between the two types of policies lies in the disclosure concept. European-style W&I Policies use a general disclosure concept, whereas US-style R&W Policies rely on a specific disclosure concept.
Both policies cover only breaches that are unknown and not disclosed. In European-style W&I Policies, breaches are not excluded from coverage if the facts or circumstances related to those breaches were not identified in the buyer’s due diligence, disclosed in the purchase agreement and its schedules, or found in other key documents such as the data room, sellers’ factbooks, or public databases.
For US-style R&W Policies, however, coverage and exclusions are determined only by the purchase agreement, its disclosure schedules, and the insurance policy itself.
Documents from the data room, due diligence reports, and public databases are not automatically considered disclosed. Insurers often include specific exclusions in the policy based on issues discovered during the buyer’s due diligence.
In general, US-style R&W Policies have fewer and narrower deal-specific exclusions and modifications than European-style W&I Policies.
On the other hand, European-style W&I Policies come with standard exclusions, such as construction defects, pension underfunding, or transfer pricing, and may have more deal-specific exclusions, like environmental concerns, especially when dealing with hazardous materials at a specific target site.
Additionally, European-style policies often include a warranty spreadsheet, which outlines coverage for each warranty, including whether it is fully covered, partially covered, or excluded.
Transaction insurers typically offer the option for buyers to disregard materiality qualifiers in a seller’s representations and warranties for purposes of transaction insurance. This is called a “Materiality Scrape.”
For example, if a purchase agreement states that a seller’s software is “in all material respects sufficient for business operations,” a Materiality Scrape would change it to say the software is “sufficient for business operations,” without the materiality qualifier.
This type of coverage is often available for an additional premium under European-style W&I Policies, although buyers may be able to choose Materiality Scrapes under US-style R&W Policies, but not for knowledge scrapes (warranties that are limited by the seller’s knowledge).
The pricing of US-style R&W Policies tends to be significantly higher than that of European-style W&I Policies. This is because it is generally easier to make a claim under a US-style policy, thanks to fewer exclusions and broader coverage.
However, claims studies show that European-style W&I Policies also experience a growing number of claims and loss payments.
In terms of underwriting, the process for US-style R&W Policies is generally quicker and more streamlined. European-style underwriting, however, involves detailed written questionnaires covering both general and transaction-specific questions.
These questions are typically answered either through an underwriting call or in writing. Despite the difference, the European underwriting process can also be completed relatively quickly when necessary.
US buyers should take an active role in the underwriting process to ensure they select the right transaction insurance for their European M&A deal. They should ask their broker to provide a non-binding indication comparing both types of policies, highlighting their differences.
This comparison will enable US buyers, in collaboration with their brokers and advisors, to make an informed decision when choosing transaction insurance for their specific deal.
US buyers should also be aware that they can still opt for a US-style R&W Policy, even if European sellers propose a European-style W&I Policy in an auction.
This is a common practice, as it allows US buyers to introduce a more Anglo-American approach to the purchase agreement while still aligning with the general structure of a European-style agreement, particularly in terms of conditions precedent or formalities related to the share transfer or European target.
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