Can a seller really cap warranty liability at £1?

How warranty and indemnity insurance can support a cleaner exit in a business sale

When selling a business, the headline price is only part of the outcome.

Sellers will also want to understand:

• Whether any sale proceeds will be held in escrow
• Whether the buyer requires a retention
• How long they may remain exposed to warranty claims after completion
• Whether a genuinely clean exit is achievable.

In the right private M&A transaction, buy-side warranty and indemnity insurance, usually called W&I insurance, can help address those concerns. This can be particularly relevant on competitive M&A processes, private equity exits and cross-border transactions, where the allocation of post completion risk can be an important part of the overall deal structure.

It may allow the seller’s direct liability for insured warranty claims to be reduced to a nominal amount, potentially £1. But that outcome is not automatic, and it will not usually apply to every risk in every sale.

The scope of cover, policy limit, retention, exclusions, due diligence, disclosure and SPA liability provisions all need to work together.

What is W&I insurance?

In a share sale, sellers will usually give warranties about the business being sold. Depending on the transaction, these may cover matters including:

• Accounts and financial information
• Tax
• Material contracts
• Employees and pensions
• Intellectual property
• Disputes
• Data protection and technology
• Regulatory compliance
• Ownership and operation of the business.

A buy-side W&I policy is designed to provide an insurance backed route of recovery where an insured warranty proves to be untrue and the buyer suffers loss.

Subject to the policy terms, limits, retention and exclusions, the insurer may become the buyer’s principal route of recovery for insured warranty claims rather than the seller. This can help bridge the gap between a buyer seeking meaningful protection and a seller seeking a clean or substantially clean exit.

Can a seller’s warranty liability really be capped at £1?

Potentially, yes. In an appropriately structured private M&A transaction using buy-side W&I insurance, a seller’s direct liability for insured general business warranties may be reduced to a nominal amount – sometimes £1.

This does not mean that the buyer is left without protection. Instead, much of the economic risk associated with insured warranty claims is transferred from the seller to the insurer.

For sellers, this can be particularly valuable where there is a desire to:

• Achieve greater certainty over sale proceeds
• Reduce post-completion exposure
• Avoid or reduce escrow and retention arrangements
• Make a cleaner exit from the business.

However, a £1 cap is not a standard entitlement. It will depend on the target, the transaction, the diligence and disclosure process, insurer appetite, policy terms and the commercial negotiation between buyer and seller.

Does the £1 cap apply to every warranty?

Not necessarily.

The £1 position is most commonly considered in relation to insured general business warranties. It should not be assumed that every warranty, indemnity or risk will be treated in the same way. W&I insurance is principally designed to respond to insured warranty claims; specific indemnities for identified risks will commonly sit outside the core W&I cover and require separate negotiation and allocation of risk.

Depending on the policy and risk profile, fundamental warranties may be subject to different limits, retentions or recourse arrangements, although enhanced or standalone cover may be available in appropriate cases.

In some cases, it may be possible to seek tailored or enhanced cover. However, this is likely to involve additional underwriting and can increase the premium. The scope of any enhancement may also be narrower than the protection a buyer might obtain directly from a seller willing to give the relevant warranty.

The practical point for sellers is that a low cap for general warranty claims should not be treated as a complete elimination of all post-completion liability.

What do policy limit, retention and de minimis mean?

The real allocation of risk is not determined by the seller’s liability cap alone. A £1 seller cap should therefore not be confused with nil retention. Depending on the policy and SPA structure, there may still be a portion below the insurer’s attachment point that needs to be allocated between the parties.

Three policy terms are particularly important:

• Policy limit – the maximum amount the insurer will pay under the policy
• Retention – the portion of loss that is not recoverable from the insurer until a specified threshold has been reached. Depending on the transaction that risk may sit with the buyer the seller or both
• De minimis – the minimum size of an individual claim before it can be brought or counted towards a wider claims threshold.

These terms affect the buyer’s practical protection and should be considered alongside the SPA’s own financial thresholds, claim periods and liability limitations.

When is W&I insurance likely to be suitable?

W&I insurance is increasingly used across private M&A, including corporate-led acquisitions and disposals, PE-backed transactions and founder-led sales. It can be relevant to a range of transaction sizes, rather than only the largest deals.

Its suitability will commonly depend on:

• The value structure and complexity of the transaction
• The nature of the target business and the sector in which it operates
• The scope and quality of the buyer’s due diligence
• The seller’s disclosure process
• The insurer’s appetite for the risk
• The policy limit retention and exclusions
• The buyer’s financing arrangements
• The commercial agreement reached between buyer and seller.

It may be particularly helpful in a competitive, cross-border or private-equity-backed sale process where sellers want to offer meaningful buyer protection without accepting extensive residual liability.

Is W&I insurance only a buyer protection product?

No. Although the buyer is usually the insured party under a buy-side policy, W&I insurance can be an important seller-side transaction tool.

It can help reconcile two competing objectives:

• The buyer’s wish for meaningful protection if warranties prove inaccurate
• The seller’s wish for a low liability cap certainty over sale proceeds and a cleaner exit.

For sellers, the potential advantages include:

• Reduced direct liability for insured warranty claims
• Reduced or avoided escrow and retention arrangements for general warranty exposure
• An insurance-backed recovery route for the buyer
• Greater certainty over proceeds following completion
• Less long-term financial exposure after the sale.

For a founder, management shareholder or PE investor, this may be as important as the headline price itself.

Who pays for W&I insurance?

There is no universal rule.

The buyer may pay the premium, the seller may contribute, or the cost may be shared. The right commercial outcome will depend on matters including:

• The competitiveness of the sale process
• The parties’ relative bargaining strength
• Buyer expectations
• The seller’s objective of achieving a low liability cap
• The overall transaction economics
• Whether private-equity or debt financing is involved
• Whether a premium contribution avoids a more costly escrow retention or higher seller liability cap.

A seller contribution can be commercially sensible where it supports a cleaner exit and reduces a more significant post-completion exposure.

What risks may remain with the seller?

W&I insurance principally responds to unknown risks in areas which have been properly diligenced. It is not generally a solution for a known issue identified during diligence or disclosure.

Certain matters may therefore be excluded from cover, require separate treatment or remain the subject of direct seller liability. Depending on the policy and the transaction, these may include:

• Known issues
• Specific tax exposures
• Leakage
• Regulatory or compliance matters
• Environmental issues
• Certain cyber data protection or technology risks
• Specific indemnities
• Forward-looking statements
• Fraud.

A known issue may need to be addressed through a specific indemnity, price adjustment, escrow, retention, bespoke tax or other specialist risk insurance, or another negotiated allocation of risk.

What is the difference between a warranty and an indemnity?

A warranty is a contractual statement about the target business. If it proves untrue and the buyer suffers loss, the buyer may have a claim for breach of warranty.

An indemnity is generally a promise to compensate the buyer for a specified loss or liability. It is often used where a particular identified risk requires bespoke treatment.

Whether a matter is dealt with through a warranty, indemnity, disclosure, price adjustment, retention, escrow or insurance will depend on the transaction and the nature of the risk.

Why should W&I be considered early in the sale process?

W&I insurance is most effective when considered before the warranty and liability structure has been finalised.

An early assessment allows the parties to:

• Consider whether W&I is suitable for the transaction
• Approach insurers and understand their underwriting requirements
• Identify potential exclusions and uninsured risks
• Plan an appropriate diligence and disclosure process
• Assess policy limit retention and de minimis
• Negotiate premium allocation
• Consider whether escrow or retention can be reduced or avoided
• Align the policy with the SPA warranty tax covenant and liability regime.

For non-consumer insurance contracts, the insured must make a fair presentation of the risk before the insurance contract is entered into. This reinforces the importance of a disciplined underwriting process and clear presentation of the diligence material.

Key takeaways for sellers

• A seller’s liability for insured general warranty claims can potentially be reduced to a nominal amount including £1 in the right transaction
• A £1 cap does not necessarily apply to fundamental warranties known issues specific indemnities or other uninsured risks
• Policy limit retention and de minimis are central to the practical allocation of risk
• Tailored or enhanced cover may be available in some cases but may require further underwriting attract a higher premium and offer narrower protection than direct seller warranties
• W&I insurance can help reduce or avoid escrow and retention but it does not remove the need for careful SPA drafting diligence and disclosure
• W&I should be considered early so that the policy underwriting process and transaction documents can be aligned.

How we can help

Thomson Snell & Passmore’s Corporate/M&A team advise on complex domestic and cross-border M&A, including private equity backed and other strategically significant transactions. We regularly advise on transactions involving W&I insurance, where it is important to align the commercial deal, insurance process, due diligence, disclosure and SPA liability framework.

Disclaimer

This article is for general information only and does not constitute legal advice. The availability, scope and suitability of W&I insurance will depend on the particular transaction, target, due diligence, disclosure, policy terms and underwriting.