What is W&I insurance?
In a business sale, the seller usually makes representations about the company: for example, that its accounts accurately reflect its financial position, that it is up to date with its tax obligations, or that there are no material undisclosed legal disputes. These representations and warranties help the buyer to assess what they are acquiring.
If a representation proves to be inaccurate and causes a financial loss, the buyer may make a claim in accordance with the contract. W&I insurance covers certain losses arising from a breach of the insured warranties, subject to the limits and conditions of the policy.
The most common form is insurance taken out by the buyer, which allows them to make a claim directly against the insurer for covered breaches. In the case of insurance taken out by the seller, the policy may protect them against any liability they retain towards the buyer. The specific structure depends on the transaction and the terms agreed.
Thus, the insurance can help reconcile two objectives: ensuring the buyer has a means of recourse against certain unknown risks, and enabling the seller to limit the liability they assume after the sale. It can also reduce the need to withhold part of the purchase price or place it in an escrow account, although it does not always eliminate these mechanisms.
What can it cover?
Cover is determined on the basis of the warranties in the sale and purchase agreement, the available information and the insurer’s risk analysis. Depending on the policy, it may include losses relating to accounts, taxes, employees, contracts, intellectual property or regulatory compliance.
It is not enough for a warranty to appear in the contract for it to be insured. It is necessary to check that it is included in the policy, how it is worded and whether it is subject to conditions or exclusions. Furthermore, some policies cover certain defence costs or third-party claims, but this scope must also be expressly stated.
It is important to distinguish between general cover and specific indemnities agreed for risks that have already been identified. If the due diligence review of the company identifies, for example, a specific dispute, the parties may agree that the seller shall be specifically liable for it. That identified risk may fall outside the scope of the W&I insurance, unless the insurer expressly agrees to cover it.
Limits and exclusions to be reviewed
The policy sets a maximum sum assured, i.e. the total amount the insurer could pay out for covered claims. The Insurance Contracts Act stipulates, for indemnity insurance, that the sum assured represents the maximum limit of indemnity.
It may also specify:
- A minimum amount per claim (de minimis): below this amount, an individual loss cannot be claimed under the policy.
- An excess or retention: the amount the insured must bear before the insurer pays out, in accordance with the agreed mechanism.
- An aggregate limit: the total maximum amount the insurer will pay out for all claims.
- Different time limits depending on the cover: some types of cover may have different durations to others. The deadline for notifying a claim must be clearly identified.
Exclusions are also essential. It is common for events known to the purchaser, contingencies revealed during the due diligence process, certain price adjustments or specific special risks to be excluded, to varying degrees. The treatment of tax, environmental or regulatory risks, for example, may vary depending on the transaction and the policy.
Generally speaking, insurance is designed to cover risks that were unknown at the time the policy was taken out. If a contingency appears in the due diligence reports or is expressly communicated to the buyer, the insurer may argue that it is not an unknown risk and exclude it. It is therefore important to review what information was provided, what the buyer was aware of, and what is set out in the exclusions to the warranties.
The policy must be read in conjunction with the sale and purchase agreement: if the two documents use different definitions or set out incompatible procedures, a dispute may arise precisely when cover is needed.
Applicable law and the policy
Law 50/1980 on Insurance Contracts requires that the terms and conditions of the insurance be clear and precise. It also stipulates that clauses limiting the insured party’s rights must be highlighted and specifically accepted in writing, and that the policy must describe the cover, exclusions and limits.
In international transactions, it is also necessary to check which law governs the policy and which courts would have jurisdiction over a dispute. The applicable law may affect the interpretation of the cover, time limits and the obligations of the parties. It is therefore unwise to assume that Spanish law will automatically apply to any W&I policy linked to a transaction in Spain.
How to respond to a potential claim
The process begins before a problem arises: the buyer and the management team must know which warranties are covered, where claims are to be reported and what time limits the policy sets out.
When a potential loss arises, it is advisable to:
- Report it promptly and through the designated channel. If the Spanish Insurance Contracts Act applies, Article 16 sets a general time limit of seven days from the date the loss becomes known, unless the policy grants a longer period. The Act provides that late notification may give rise to a claim for damages caused by the delay. At the same time, the W&I policy may set out its own notification requirements, so it is important to comply with these and not to wait until the final amount of the loss is known.
- Link the facts to the relevant cover. The notification must explain which representation in the contract may have been breached and why the event, in principle, falls within the scope of cover.
- Provide supporting documents and explain the loss. Contracts, reports, correspondence and calculations help the insurer assess the case. If the amount cannot yet be determined, this should be stated, and the claim updated as new information becomes available.
- Coordinate the response to third parties. If the incident stems from a claim by a customer, employee or authority, the policy may require that the insurer be informed and that its consent be obtained before accepting liability, reaching a settlement or incurring certain expenses.
- Reasonably minimise the damage. The insured must take action to prevent the loss from increasing.
The Insurance Contracts Act sets out this obligation to minimise the consequences of the loss.
For example, if, after completion, a tax claim is received relating to a period prior to the sale, the purchaser should review which tax warranty is covered, check the deadline and method of notification, and report the matter to the insurer. Before accepting a settlement or reaching an agreement, they must verify whether the policy requires the insurer’s consent.
Coverage that requires preparation
W&I insurance can facilitate a transaction and provide a response to certain breaches of the seller’s warranties. However, it does not automatically cover all the company’s risks, nor does it replace the legal, financial and tax due diligence of the transaction. Its effectiveness depends on the contract and the policy being aligned, on the exclusions being understood, and on claims being reported and documented correctly.
At Belzuz Abogados S.L.P., we draw on our expertise in Insurance Law to analyse the insurance issues that may arise in relation to W&I policies and claims arising from M&A transactions. In each case, it is advisable to jointly review the policy, the sale and purchase agreement, the applicable law and the specific circumstances of the loss.