Introduction

In every Share Purchase Agreement, there exist separate sections on ‘Representation and Warranties’ for the seller and buyer. The Indian Contract Act, 1872 does not provide a definition for the term ‘representation’.  The Sale of Goods Act, 1930 defines warranty as a collateral stipulation to the main purpose of the contract; the breach of which will give rise to a claim for damages.  In the case All India General Insurance Co. v. S.P. Maheswari, the Madras High Court states that the duty of disclosure comes under two heads—representation and warranty. Representations can be of two types: the basis of the contract is a warranty, and the essence of the contract is a representation.

By virtue of the Representation & Warranty clause, the buyer warrants the seller and the seller warrants the buyer that all representations made in respect of the agreement are true, accurate, and not misleading. However, in practice, the buyer shall always try to seek broad representations and warranties from the seller as a part of definitive documents, while on the other hand, the seller will attempt to seek to reduce its exposure by providing limited warranties to the buyer. There is a void that is generated due to the different demands and needs of the buyer and the seller. This void can be bridged by availing warranty and indemnity insurance.

W&I insurance policies provide coverage for breaches of representations and warranties including tax liability made in SPA. It offers buyers and sellers a powerful tool that enables them to mitigate and improve risk as they enter into deals, giving protection against a wide range of losses resulting from these unknown risks.  

Sell-side

One aspect of W&I insurance is the seller side. The sell-side policy is an agreement between the seller (the insured) and the insurance company (the insurer). According to the policy, if any valid claim is brought against the insurer by the buyer for any breach which is explicitly covered by the terms of the policy, the insurer shall reimburse the insured duly.

Buy-side

The other aspect is the buy-side insurance. This is developed as a consequence of the seller’s unwillingness and inability to provide the necessary level of coverage. The insurance ensures protection to the buyer in cases where the seller places a cap on the level of warranty. Under this policy, a buyer suffering a loss may bring a claim against the seller till the agreed cap as per the agreement and at the same time, inform the insurance company of the same as well. If the claim is valid, the buyer shall have recourse to be indemnified by the seller up to the cap and also can obtain a settlement from the insurance company as per the terms of the policy. Thus, the important point to be noted by the buyer is that the cap under the SPA and the policy coverage match and that there are no gaps between them. Another feature of the policy is that the insurance company shall require the buyer to bear the first part of the warranty claim, which is the excess to the amount agreed under the SPA.

Exclusions

Each policy states certain points as ‘exclusions’. These are a list of claims to which the W&I policy will not apply. If any of the listed items take place, the insured is barred from claiming from the insurer. Below are a few items that form part of such exclusions:

General Exclusions

1. 1. 1. Disclosure: all things expressly disclosed by the seller under the SPA are excluded from the policy.
      2. Buyer’s knowledge: any information/act/omission that the buyer has prior knowledge of. This can be gained while conducting due diligence, or it may be a public knowledge in the market.  
      3. Fines and penalties: all civil and criminal fines which are imposed on the insured company post the closing of the SPA due to the wrongful acts of the insurer are also excluded generally.
      4. Specific exclusions are stated in the policy.

Insurance services are on the rise due to the following reasons:

1. It helps bridge the gap for the buyer. W&I can be availed to increase the coverage of the buyer.

2. It allows the seller to have a clean exit with a certain amount of sale proceeds.

3. It ensures the buyer of some covenant strength when the seller is in financial distress.

Need for R&W Insurance

Telenor had purchased a certain stake in Unitech in 2011. Subsequently, the Supreme Court of India passed a judgment where it revoked 122 licenses issued to all telecom operators after January 10, 2008, including those issued to Uninor of the Unitech Group. Telenor filed a case against Uninor for breach of warranty and representations, as it believed that the legality and validity of the licenses was a fundamental term of the agreement. The Company Law Board later allowed the parties to settle disputes through arbitration.

Analysing the above-stated case, one can understand the need for an R&W insurance policy. It acts as a safety net for the buyer and for the seller; it allows for a clean exit. However, it is essential that the insured company undertakes proper due diligence before entering into a merger and acquisition transaction.

Case Study

• Financial statement breach (US)

A buy-side W&I policy was availed from AIG by a global manufacturer of sporting goods while undergoing an acquisition.  Before the closing of the transaction, the buyer calculated the company’s annual earnings as reported in the audited financial statements. But when the buyer recalculated the earnings of the company post the closing of the transaction, there was a difference between the two calculations. It was contended by the buyer that the higher valuations at the time of the transaction caused overvaluation and that the seller breached its representations regarding the financial statements and compliance to applicable laws. After AIG investigated the matter, it was found that there were indeed breaches of representations and that the buyer had provided documentation to support it claim for the loss. AIG quantified the amount of the buyer’s loss and paid the coverage amount as per the policy.  

• Asahi and Pacific Equity Partner

The Japanese beer-and-beverage maker Asahi Group acquired Independent Liquor from Pacific Equity Partners in 2011. However, within twelve months of taking ownership, Asahi discovered that the business was far less profitable than it had claimed. Subsequently, Asahi Group sued Pacific Equity Partners for the misrepresentation of the company’s finances. Later, a settlement was reached between the parties, and it was understood that AIG, Beazley Breach Solutions, and Allied World Assurance Company would pay a certain amount of the settlement and the remaining would be paid by the other parties of the agreement.

• Ageas Ltd. v. Kwik Fit (GB) Ltd & Anr

A claim arising out of a SPA was brought before the England and Wales High Court (Queen’s Division Bench). Under the agreement, the Claimant (Ageas) acquired from the First Defendant( Kwik Fit [GB] Ltd.) the entire issued share capital for consideration. At the same time, Ageas took out a W&I insurance policy from the second defendant (AIG) to protect the company against the loss resulting from the breach of warranty in excess of the five-million-dollar cap. Under the SPA, Kwik Fit had warranted the truth, fairness, accuracy, and compliance with relevant accounting standards. However, it was subsequently found that Kwik Fit has breached those warranties. In the end, AIG admitted liability under the policy, and the claim was settled.  

Conclusion

Over recent years, there has been an increase in W&I insurance users. This implies that though there is rigorous due diligence being undertaken by the parties, there still remains some element of risk. a trend has been noted that The frequency of claims being raised in the first twelve months is higher than in the twenty-four months from the date of the policy being taken out. T. Such a policy serves as a safety net for the buyer and the seller in any merger and acquisition transaction. On the buy-side, the buyer is protected to a limited extent from any misrepresentation or breach of warranty, while the sell-side gives the seller an opportunity to make a clean exit. However, no party to a merger or acquisition can do away with due diligence. The W&I insurance policy does not cover all breaches, and any breach resulting from the negligence or wrongful act of the insured shall not be covered. This policy has grown to be an important instrument in all M&A transactions, especially with the increase in the number of joint venture agreements.

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