Q&A: Warranty and indemnity insurance in the Middle East

July 2024  |  SPECIAL REPORT: MERGERS & ACQUISITIONS

Financier Worldwide Magazine

July 2024 Issue

FW discusses warranty and indemnity insurance in the Middle East with Simon Dodsworth, Adnan Chida, Neo Combarro and Ross Lima at Lockton.

FW: How prevalent is the use of warranty and indemnity (W&I) insurance as part of M&A transactions in the Middle East? How would you characterise current appetite for this form of insurance?

Chida: Over the last couple of years, and in particular in the last 18 months, warranty and indemnity (W&I) insurance has undergone a noticeable shift in uptake. It has gone from a comparatively unheard of risk product to being something that is discussed, if not necessarily used, on the majority of M&A transactions. There are a number of reasons for this, including greater engagement by legal and other M&A advisers, greater competition and focus on the Middle East and North Africa (MENA) region by international insurers looking to deploy capital, and a virtuous cycle of greater understanding and familiarity of the product followed by the positive experience of its use on transactions. Appetite is at an historic high, but there is considerable room for growth before W&I insurance comes close to reaching the level of pervasiveness seen in more mature markets like the UK, Europe and the US. I do not anticipate future development being linear; rather, as the ecosystem of brokers, lawyers, financial advisers and, in due course, locally based insurers grow, I think we are primed for exponential growth when it comes to the use of W&I insurance. It is not just brokers and local insureds that are focusing on the MENA region when it comes to W&I insurance, insurers too are increasingly seeing the opportunity to leverage the M&A environment and in a number of cases are actively exploring the possibility of deploying W&I underwriters on the ground, so that they are better placed to benefit from increasing W&I insurance activity.

“Due diligence is the bedrock of W&I insurance. If a matter is appropriately diligenced, the associated warranty can generally be insured.”
— Ross Lima

FW: In what ways is the approach to transactional risk management in the Middle East similar to Western jurisdictions? How is it different?

Chida: In many ways, the approach to transactional risk management in the MENA region is similar to that in the UK, Europe and the US 10 to 15 years ago. Historically, M&A principals and advisers would be more comfortable using an escrow mechanic, price-chips or even walking away from a deal than using W&I insurance. That position is definitely changing quite markedly. There are still challenges though, when it comes to changing perceptions and approach in the MENA region. Conversations around using W&I insurance are still happening later in the transaction than in other jurisdictions. That is not ideal, because it means that warranty negotiations, structuring considerations and due diligence scope are not able to factor in, and be influenced by, the use of W&I insurance on a given transaction. On the point of due diligence itself, there is still the tendency for buyers to think of W&I insurance as a substitute for due diligence, and this obviously is not the case.

“W&I policies are by their nature very technical and bespoke to every individual deal, tailored to the specifics of that deal or the insured contingent event.”
— Neo Combarro

FW: Could you outline the key characteristics of W&I policies in the region? What are the main benefits W&I brings to a transaction for both buyers and sellers?

Dodsworth: Arguably, the characteristics of W&I policies across the MENA region reflect the global appetite for coverage. The choice of law and jurisdiction with the underlying transaction is a fundamental consideration, with many reinsurers scrutinising the relationship between the transaction documents, the policyholder of the W&I policy and that of the overall insurance policy itself. Any transaction can benefit from a W&I policy, which bridges the gap between a buyer’s expectations of protection and a seller’s reluctance to hold potential liabilities in the share purchase agreement. Among the potential benefits commonly considered to be material in transactions is increased indemnification such as a higher cap, longer periods, lower de minimis and thresholds. Other benefits include differentiated terms in a bid or an auction process, and greater comfort for lenders, investors and shareholders where an additional level of security is injected into the deal. Equally, a clean exit, mitigation against a price-chip and maximising the return to investors enables sellers to use the proceeds of the sale and removes the warranty burden of the management team transferring over to the new owner. All of these factors variably benefit all parties.

FW: Are there any restrictions to utilising W&I in the Middle East in terms of deal type, structure or value? In what sectors and industries is it most commonly sought?

Dodsworth: Dependent on the underlying transaction documentation and the structure of the transaction itself, there are various solutions to manage the insurance and reinsurance arrangements. In certain cases, a direct policy of insurance can be arranged, whereas in other jurisdictions a locally issued insurance policy, backed by reinsurance, is necessary. This adds an extra layer of consideration which should be addressed at the outset of the insurer engagement. In certain cases, underwriters are not able to issue direct policies in specific jurisdictions, whereas others have gained comfort from past experience working with brokers that can guide them through the local regulations and considerations. In principle, there are no limitations on the deal type of structure, although certain insurers have a reduced appetite for domestic risks, governed by local laws and involving state-operated counterparties. In such cases, there is increased moral hazard in the event of a warranty breach and how the parties would be able to stand behind the recoverability of the insurance. While there has been increased take-up of W&I insurance across the region, whether on an inbound, interregional or outbound transaction, there is greater scrutiny of the due diligence process when it comes to technology deals – largely because the basis of valuation is predicated upon a future value of the technology rather than an historical track record. In such cases, a more detailed investigation into how the enterprise value has been calculated will be undertaken.

“There is still the tendency for buyers to think of W&I insurance as a substitute for due diligence, and this obviously is not the case.”
— Adnan Chida

FW: What considerations should companies make when taking out a W&I policy in the region? In particular, what kinds of coverage exclusions do these policies typically contain?

Lima: Due diligence is the bedrock of W&I insurance. If a matter is appropriately diligenced, the associated warranty can generally be insured. However, there are some areas where coverage is excluded or where more extensive due diligence may be required. Matters which the insured has knowledge of, such as forward-looking statements, matters which were previously agreed and dealt with via a price adjustment, as well as ‘non-permitted leakage’ in respect of a locked box transaction and fines, all of these are generally excluded from a W&I policy. Pollution is also an area frequently excluded, however, depending on the asset, the sector and the subsequent level of risk, it may be possible to obtain coverage. For energy and infrastructure assets, where such coverage could deliver significant value to the client, this could require a phase two environmental report. Lastly, an area of broadening coverage is in respect of conditions of assets, which has previously been excluded from W&I insurance. Depending on the nature of the due diligence, such as technical due diligence providing a clean report, insurers may, depending on the nature of the underlying asset, provide a level of coverage in respect of this. When the main value of a target is in large-scale infrastructure, this can be a significant enhancement to protect value in the target.

FW: What type of enhancements are typically available in connection with a W&I policy?

Lima: The most frequently taken enhancements are ‘knowledge scrapes’ where certain warranties have the words ‘so far as the seller is aware’ removed, making the warranty purely fact-based and removing an element of uncertainty from the coverage. Likewise, there are ‘materiality scrapes’, where instead of certain warranties only applying in the case of a ‘material’ impact or loss, they apply to any loss in excess of the de minimis. Calculating damages on an indemnity basis, rather than a warranty basis, offers the insured an additional level of protection, such that the insured is covered in respect of the first dollar lost. Where information is deemed disclosed to the insured, this generally results in the insured being unable to claim for a loss arising from that disclosed information. It is therefore critical that the definition of disclosure is clear and suitably narrow, so that only information which is truly made available to the insured, to the extent they are able to make an informed assessment of it, can be deemed disclosed.

“Any transaction can benefit from a W&I policy, which bridges the gap between a buyer’s expectations of protection and a seller’s reluctance to hold potential liabilities in the share purchase agreement.”
— Simon Dodsworth

FW: In the event of an actual or alleged breach that may trigger a claim, how important is the choice of insurance broker for how the claims process is handled?

Combarro: W&I policies are by their nature very technical and bespoke to every individual deal, tailored to the specifics of that deal or the insured contingent event. Where appropriate, there may be specific technical analysis and advice which supports a particular risk assessment, which is also the basis of cover provided by insurers. Claims, whether for breach of warranty or claim under an indemnity, are similarly extremely technical and require the placement broker and the underwriter to be involved from the outset, to lead and support the relevant claims professionals. It is important to always initiate early, in-person engagement to discuss the relevant notification of claim and where appropriate also the client engagement. Insureds can then be guided through the relevant exercise proving loss and then the further, highly technical area of quantifying loss. Such claims should not be handled in the usual insurance manner due to the rigorous underwriting process. They require careful management from the direct broker lead.

 

Simon Dodsworth joined Lockton Insurance Brokers LLC in 2018, having served as managing director and general manager for a number of insurance brokerage and consulting businesses across the MENA region since 2013. He has spent the majority of his subsequent career providing insurance transactional services to private equity and corporate clients on a global basis, with specific interest in Middle Eastern investors deploying capital overseas. He can be contacted on +971 54 586 9063 or by email: simon.dodsworth@lockton.com.

Adnan Chida joined the transactional risks team at Lockton in November 2022 as vice president and is responsible for W&I insurance and related transaction risk products in the MENA region. He has been in Dubai for nearly 10 years and, prior to joining Lockton, led a number of local, regional and cross-border private M&A deals for private equity houses, global companies, UHNW individuals and family offices across a wide range of values and sectors. He can be contacted on +971 56 685 9326 or by email: adnan.chida@lockton.com.

Neo Combarro leads Lockton’s transactional risks and M&A team and draws on 20 years of transactional and financial services experiences when tailoring insurance solutions to his clients’ needs. Within the last year, he has overseen the placement of W&I, tax and contingent risks insurance policies on 150-plus transactions – spanning private equity, real estate, infrastructure and energy, and accessing international markets in North America, Bermuda, Europe and Asia. He/She can be contacted on +44 (0)7833 234 290 or by email: neo.combarro@lockton.com.

Ross Lima is head of energy and infrastructure for Lockton's transactional risks team and has supported numerous renewable and traditional energy and infrastructure transactions with the placement of insurance solutions. Prior to joining Lockton, he spent nine years at Shell as senior legal counsel and led strategic M&A deals. Mr Lima has extensive sector experience, working across a breadth of upstream/downstream specialisms. Prior to Shell, he was an associate solicitor in the corporate team at Fieldfisher. He can be contacted on +44 (0)7775 392 997 or by email: ross.lima@lockton.com.

© Financier Worldwide

©2001-2024 Financier Worldwide Ltd. All rights reserved. Any statements expressed on this website are understood to be general opinions and should not be relied upon as legal, financial or any other form of professional advice. Opinions expressed do not necessarily represent the views of the authors’ current or previous employers, or clients. The publisher, authors and authors' firms are not responsible for any loss third parties may suffer in connection with information or materials presented on this website, or use of any such information or materials by any third parties.