Warranty & Indemnity (W&I) claims – some lessons to be learned so far!
News | 16.10.19Banking and Finance
Corporate and M&A
This article seeks to point out a few issues that may be learned from the recent W&I claims. But first, some statistics. Some general takeaways from the Claims Study1 are;
- Bigger deals (above USD 1 billion) had more notifications for claims in percentage of policies placed
- The time to settle a claim is reduced significantly of the years
- Substantial increase in claims relating to financial and tax-matters which account for about half of all the notifications
- The percentage for notifications vs policies issued vary between the regions. For the last 10 years, The Netherlands is on top with claims in 21% of the policies, and UK and southern Europe are about to 10% and 3% respectively. For the Nordics, there were claims in 13% of the policies.
So, what may be learned from the notifications for claims so far?
Let us state the obvious first; the general focus which is always relevant with regard to W&I insurance policies. When we act on behalf of insurance companies, we try to identify matters that are (i) insufficiently defined, (ii) not fairly disclosed or (iii) have not been subject to a due diligence of appropriate measures. Lastly, we safeguard that the drafting of the representations & warranty clauses does not stretch out for more than what is covered by the three former points, it all adding up to the following question: What measures have been taken in order to verify each and every R&W-clause, and each and every alternative in such clause?
Having stated the above as the overall and general focus, let's look into some particular issues from recent W&I claims cases:
1. Financial Statement
Unless the matters are clearly defined and a sufficient diligence is conducted, the insurer should be reluctant to let the policy include matters like:
a) Representations that cover the completeness, correctness and adequacy of the "books and records", as "books and records" normally are not sufficiently defined.
b) Representations that cover the sufficiency of internal controls and procedures to uncover fraud or other errors in the financial statements, records, etc.,
c) Representations that cover off-balance sheet items.
2. "Full Disclosure", "Loyal Disclosure"; "Information" etc.
The next issue we would like to point out is representations relating to the seller's "duty of loyal disclosure", "full disclosure", etc. The interpretation of these kind of clauses may of course vary significantly between the different jurisdictions. However, bearing in mind the general focus pointed out above, the relevant question is still what measures have been taken in order to verify the general sort of representation about a full disclosure. Obviously, these sorts of representations are difficult to verify and should as a starting point be excluded from the policy, or alternatively, be made subject to seller's knowledge or other sorts of tightening-up.
3. Importance of Audited Financial Statements
Even though the seller's representation regarding financial statements seems to be of the customary kind, and the buyer have conducted a customary financial due diligence, there are still some lessons to be learned with regard to "accounting irregularities":
a) Was the audit conducted by a reputable accounting firm?
b) Did the accounting firm identify any irregularities, lack of internal control, experienced any restatements of financial statements, etc.?
c) Did the scope of the buyer's financial due diligence include matters like internal control?
In our view, these three questions should be deemed a natural part for the preparatory work before issuing a W&I policy.
As notifications for tax claims now represent about a quarter of all notifications4, it should be needless to say that proper focus on tax matters are of importance. The following three tax matters represent about three quarters of all tax claims;
a) corporate income tax,
b) employment tax, and
c) sales tax
As these three tax matters are tightly related to the operation of the targets business, it is hard to extract some unique lessons to be learned from claims relating hereto, except for stressing the obvious again, the necessity of a proper scoping for the tax due diligence and a fair quality check of the drafting of the tax representation not being too wide compared with the tax due diligence conducted.
1) Marsh Jlt, July 2019:
2) Harvard Law School Forum on Corporate Governance and Financial Regulation on 25. April 2019,
3) The Actuary, the magazine of the Institute & Faculty of Actuaries on 21 August 2019: https://www.theactuary.com/news/2019/08/huge-rise-in-wi-insurance-claims-recorded/
4) The Merger and Acquisition 2019 Claims Report by AIG: