6.9.2023

Taking into account W&I insurance in due diligence reviews and negotiations for sale and purchase agreements

The purpose of warranties and indemnities insurance is that the insurance company assumes the seller’s liability for damages in case one of the seller’s warranties has been breached. The basic requirement for getting an insurance is that the buyer conducts a careful due diligence review of the object of transaction because the insurance only covers unknown risks for which the seller has given warranties in the sale and purchase agreement. It is therefore important to bear in mind that the insurance does not cover findings of the due diligence review, but instead the parties have to agree how liability for the observed findings is allocated.

In our previous blog, we wrote about how W&I insurance supports the risk management of real estate transactions. We discussed briefly what W&I insurances are about and for what kind of transactions they are suitable. In addition, we shared our best practical tips for taking out W&I insurance. In this blog, we will review how the insurance affects the contents of the sale and purchase agreement and the buyer’s due diligence review.

W&I insurance affects the contents of sale and purchase agreements

A conventional sale and purchase agreement includes certain seller’s warranties for the object of sale and purchase that are agreed between the parties. The purpose of a W&I insurance is that the insurance company assumes the seller’s liability for damages in the event that one of the seller’s warranties has been breached. Even though the liability for damages in an insured sale shifts to the insurance company, it is good to keep in mind that the seller’s warranties must be as valid in an insured sale as in a sale without a W&I insurance. From the seller’s perspective, it is a good idea to agree in the sale and purchase agreement that the buyer can only make claims to the insurer and not to any extent to the seller.

In the terms and conditions of a W&I insurance, the insurer can exclude some of the seller’s warranties so that their breach will not be compensated from the W&I insurance. The potential damages caused by the seller’s breach of such warranty will be borne by the buyer, unless the parties have agreed in the sale and purchase agreement that the seller is liable for such breaches. The seller may, however, become liable for the breaches of the warranties if it has caused them wilfully or through gross negligence. It should be kept in mind that the W&I insurer is entitled to claim compensation from the seller for the damage it has compensated if the damage is caused by the seller’s wilful or grossly negligent breach of the warranty. Usually the terms and conditions of the insurance also exclude the seller’s warranties relating to the pollution of soil or groundwater and taxation of transfer pricing. However, there are insurances on the market that target the risks relating specifically to these.

If the parties agree on separate signing of the sale and purchase agreement and completion of the sale, a separate new breach cover must be taken to cover breaches of the seller’s warranties between the signing and the completion if such coverage is required. In the sale and purchase agreement, the parties can also agree how liability for these breaches of warranties is allocated between the parties. If the time between the signing and the implementation is long (as is often the case in forward purchases), it should be ensured whether the insurer is willing to provide insurance cover for such a long period of time.

The insurer investigates the buyer’s due diligence review

A basic requirement for getting an insurance is that the buyer conducts a careful due diligence review of the object of sale and purchase. It is the buyer’s duty to conduct a comprehensive legal, commercial, technical, environmental and tax due diligence review. As part of the preparations of the insurance policy, the insurer also conducts its own review based on the buyer’s reports and the information submitted by the seller for the due diligence process. The insurer insures the seller’s warranties of the object of sale and purchase only to the extent the matters covered by the warranties have been reviewed as part of the buyer’s due diligence review.

The W&I insurance only covers unknown risks for which the seller gives warranties in the sale and purchase agreement. It is therefore important to bear in mind that the insurance does not cover findings of the due diligence review, but instead the parties have to agree how liability for the known findings is allocated. In such a situation, the buyer can seek to include in the sale and purchase agreement the seller’s specific undertakings on how the seller ensures the implementation of measures or bears the costs thereof. One solution could also be a reduction of the purchase price by a sum corresponding to the finding.

It is possible to agree on the costs of the W&I insurance

The parties can agree how the insurance costs are allocated between the parties. Often the premise is that the buyer bears the insurance premium. If the seller will be dissolved or ceases to exist after the completion of the sale, a W&I insurance may be a requirement for the sale. In such a case, the parties may agree to allocate the costs between the seller and the buyer.

Latest references

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