Transactional Risk Insurance
Transactional risk insurance—known as representation and warranty insurance (RWI) in the United States and warranty & indemnity (W&I) insurance in Europe—allows parties to allocate risk of breaches of the underlying transaction agreement or other specified occurrences to a third-party insurer. Although the market for W&I insurance has taken longer to become entrenched in Spanish M&A practices relative to the United States and other European jurisdictions, the product has exploded in recent years, in part, due to transactional risk underwriters establishing local operations in Spain, specifically in Barcelona, to increase the exposure and reach of their product, leading to a huge surge in the rate of usage of transactional risk insurance in Spain. A more competitive underwriting market has also led to opportunities for more M&A parties to utilize the product. As more and more M&A transactions in Spain involve insurance, it is imperative that transaction parties understand the operation and incentives of this important risk allocation tool.
The operation and benefits of transactional tisk insurance policies
In most M&A transactions, the seller will make a set of representations and warranties that speak to the quality and value of the assets and rights being conferred by the transaction. In the event of a breach of these representations by the seller in a non-insured transaction, the buyer would seek recourse from the seller, either in law or through the indemnification procedures set forth in its agreement. When a transactional risk insurance policy has been implemented, the buyer makes a claim to the insurer instead of the seller for such losses.
Engaging a transactional risk insurer can be especially enticing to buyers for a number of reasons, including:
- To replace a seller who may be recalcitrant in responding to claims with an insurer incentivized to facilitate and payout claims
- To create means of recourse when there is concern the sellers may be dissolved or insolvent
- To preserve important commercial relationships such as retained employees or vendors/clients
- To close gaps in negotiations between buyer and sellers
- To improve their offer in a competitive auction process
A seller may also be motivated to implement an insurance policy for the following reasons:
- To obtain a “clean exit”
- To avoid escrows or retentions that delay receipt of the full purchase price
- To limit or eliminate post-closing liability or obligations
- To increase value by offering stronger representations
A policyholder selects an insurer after receiving a non-binding indications report from the broker containing offers of insurance from several underwriters. Policy offers can be differentiated by, among other terms, premiums, de minimis provisions, and policy exclusions.
COVID-19 and Beyond
When the COVID-19 pandemic began in the early spring, outside of a few sectors, M&A activity experienced an abrupt downturn and transactional risk underwriting followed suit. Without the normal influx of new deals, underwriters generally only saw activity in deals that had already begun implementing a policy. Just as M&A activity came back online, underwriting activity also resumed. Underwriters began weighing the incorporation of a COVID-19 exclusion for new policy. Still a relevant topic, the COVID-19 exclusion appears to have lost favor due its broad nature, and underwriters may express their willingness to remove it so long as no issues are identified in the underwriter’s due diligence. Like many elements of the current economy, the true impact of COVID-19 on the transactional risk insurance market remains unclear. Certainly, one would expect a decrease in M&A activity due to general economic conditions. It would seem to follow that underwriting activity would also retract. However, underwriters are confident that they can maintain their growing presence in Spanish M&A.
There is no question that the market for transactional risk insurance in Spain has grown in recent years, and while the current economic circumstances present some uncertainty, the large number of underwriters now operating in Spain are able to reach a growing base of corporate M&A parties by offering competitive financial and coverage terms. By understanding how the product is implemented and how its risk allocation incentives operate, M&A parties can account for their own financial and risk limitations and achieve more favorable outcomes in their deals.
Más información: Ignacio Bassas y Jarrett Baughman, abogados del área de Derecho Mercantil.