Warranty and liability insurance are a strategic necessity in mergers and acquisitions

The Kenyan mergers and acquisitions (M&A) market has seen a significant increase in warranty and indemnity (W&I) insurance, indicating a fundamental change in the way deals are structured and executed.

This highlights the need for W&I insurance to mitigate risk and enable smoother, more secure transactions.

Insurance provides sellers and buyers with additional security by ensuring sellers have a smooth exit from the transaction and reducing buyers’ concerns about the seller’s ability to honor warranty or indemnity claims after the transaction.

Historically, W&I insurance has been more prevalent in cross-border transactions, particularly in regulated sectors such as insurance, banking and private equity. While its adoption is gaining ground locally, particularly among private equity sellers, W&I insurance remains underutilized in purely domestic transactions. Nevertheless, it offers significant protection to parties involved in M&A transactions.

Buyers gain the assurance that they will be compensated in the event of a breach of warranty or damages, which reduces the financial risk associated with the transaction.

For sellers, this provides a smooth exit, free from the risk of future claims, allowing them to focus on new opportunities without the burden of unresolved obligations.

However, to maximize the benefits of W&I insurance, it is crucial to incorporate it early in the transaction process. A comprehensive understanding of the target business, obtained through rigorous due diligence, is essential for both parties and the insurer.

This due diligence forms the basis on which the guarantees and indemnities in the sales and purchase agreement are drawn up. These carefully drawn up W&I then form a solid basis for insurance.

W&I insurance provides solid protection, but it comes with several challenges and issues that parties must address:

Financial consequences: W&I insurance can be expensive, particularly in high-risk sectors where the likelihood of claims is higher. Parties must weigh the benefits of insurance against the associated costs.

Policy limitations: Limits, deductibles and exclusions may limit your overall coverage, so please read your policy terms carefully.

Impact on transaction schedule: The underwriting process, including broker appointment, underwriting, policy negotiation, and integration with the sales agreement, must align with the broader transaction timeline. W&I insurance relies on due diligence to determine coverage, and delays in this process can impact the overall transaction timeline.

When deciding whether to include W&I insurance in an M&A transaction, there are several factors to consider:

First, industry and transaction factors. The size of the target business significantly impacts the need for W&I insurance. Industries with complex regulatory frameworks or higher risk profiles may benefit more from coverage.

Secondly, the scope of the policy and its assessment. The scope of coverage is paramount. Parties should carefully evaluate the specific guarantees and indemnities to be insured. A balanced approach, including comprehensive coverage and reasonable exclusions, is essential.

As more companies see the value of this solution, it will likely become the standard in M&A transactions, ushering in a new era of safe and efficient transaction execution.

Accurate analysis and comprehensive disclosure are crucial as they influence the insurer’s assessment of the risk profile.

Third, Policy Terms: The policy duration, usually 12 to 36 months, must be consistent with the potential exposure period. In addition, the agreed deductibles and excesses will affect the total cost of insurance.

A thorough understanding of the claims process, including notice requirements and dispute resolution mechanisms, is critical to effective risk management.

Fourth, compliance with the purpose of the transactions: W&I insurance should not be considered in isolation, but as part of a broader risk management strategy that is aligned with the overall transaction objectives. Early integration and careful planning can help ensure that W&I insurance enhances, rather than complicates, the transaction.

While W&I insurance offers significant benefits, it is not without its challenges. Cost, potential policy limitations, and the need to accommodate a broader transaction timeline are all factors that must be carefully managed.

However, for those who can navigate these complexities with foresight and precision, W&I insurance can transform the way deals are structured and implemented in Kenya.