What is meant by a “synthetic” W&I insurance policy in an M&A transaction?

Contrary to a standard buy-side W&I policy, the warranties insured in respect of a business or asset being sold by a seller to a purchaser (the Insured) are contained in the W&I policy instead of the sale agreement or the warranty deed.

In certain circumstances, the sale agreement or the warranty deed may contain a limited suite of warranties, for instance title & capacity warranties, with a W&I policy synthetically extending the catalogue by insuring market-standard business and tax warranties.

What are the key differences between a synthetic W&I policy and a standard buy-side W&I Policy?

• In a synthetic W&I policy, the insured warranties are not given by the seller or the warrantor and are agreed with the Insurer instead. The warranties catalogue in a synthetic W&I policy tends to be more limited and focussed on key areas of the target’s business.
• In a standard buy-side W&I policy, the seller or the warrantor may qualify the warranties it gives by reference to specific disclosures, for example disclosure schedules, a disclosure letter or a bring down statement. This does not happen on a synthetic W&I policy. Instead there may be a limited set of general disclosures, for example matters that would be revealed from specific public searches.
• Standard limitations in respect of warranty claims that are usually in a sale agreement or a warranty deed such as mitigation, subsequent change in law, no double recovery, are instead contained within the W&I policy itself.
• In a standard buy-side W&I policy, the Insurer reserves the right to subrogate against the seller or the warrantor in the event they pay a claim of the purchaser (the Insured under the Policy) which arose from the seller’s or the warrantor’s fraud. Such subrogation right for the Insurer does not exist in a synthetic W&I policy.
• Pricing for a synthetic W&I policy is generally higher than a standard buy-side W&I policy. This is due to the additional underwriting time for the Insurer and the increased risk allocation to them.

What are the advantages of a synthetic W&I insurance policy?

• A purchaser is able to obtain contractual protection for certain aspects of the business they are acquiring which they would not otherwise be able to obtain from a seller or a warrantor.
• The Insurer may agree to a more focussed due diligence exercise (and limited and targeted underwriting questionnaire) that aligns with the synthetic warranties to be insured. This can save on time and cost for the Insured.
• Negotiation of the warranties can be more efficient due to it being solely between the Insured and the Insurer, as opposed to a standard buy-side W&I policy which also involves the seller. It also positively impacts the SPA negotiations by moving the warranty workstream outside of the general transaction discussion.
• In an auction process, a prospective purchaser could use a synthetic W&I policy to enhance its bid due to: (a) fewer or no warranties being required from the seller, thereby giving them a clean exit; and (b) a reduction in the time and cost spent on negotiation of the sale agreement, thereby creating a more efficient process.
• In an insolvency sale situation, the sale price can be maximised because the historic liability risk of the business or asset is passed on to the Insurer.

Where can a synthetic W&I policy be beneficial?

• Distressed M&A – a business being sold is insolvent and the insolvency practitioner conducting the sale is not giving any warranties (e.g. the sale is on an “as is” basis).
• Public to private transactions – where it is not feasible to seek warranties from all sellers, due to ownership dilution.
• State entities – where the seller is a state or government entity and is not able to give any or many warranties due to regulatory issues.
• Passive investor’s exit – where the seller (often being a minority shareholder) is a passive investor unwilling (or unable) to give any warranties due to limited or no knowledge of the current state of affairs of the target.
• Carve-out sale – a purchaser seeking to divest a part of the business it has recently acquired for strategic reasons. In this on-sale scenario, the second purchaser may seek a synthetic policy as the original purchaser will not have owned the business for a meaningful period of time to be able (or willing) to give warranties.

Tips when considering a synthetic W&I policy

• Early engagement with a W&I broker (such as Marsh), who can advise you on how to structure your transaction to complement a synthetic W&I policy, is vital to ensure an efficient and seamless process.
• If you are a seller and a purchaser is going to be taking a synthetic W&I policy:
  • Populate the virtual data room with all relevant documentation to the business being sold so the purchaser can conduct an appropriate due diligence process.
  • Respond to the due diligence Q&A of the purchaser. Both can help a clean exit and potentially enhance the deal value.
• If you are a purchaser and the Insured under the synthetic W&I policy:
  • Where seeking warranties to be insured on a synthetic basis, demonstrating to the insurance underwriter (such as Brockwell Capital) that the synthetic warranties has been subject to a focussed due diligence exercise is key.
  • In the absence of a disclosure process by the seller, you may wish to consider additional diligence Q&A closely around the subject matter of the synthetic warranties that are to be covered in the synthetic W&I policy.

For further information please contact: 

Jai Patel, Senior Underwriter, Brockwell Capital Jai.patel@brockwellcapital.com

Wojciech Sobierajm, Marsh Poland wojciech.sobieraj@marsh.com