Legal Flash: W&I Policies in M&A Transactions - Evolution, Benefits, and Legal Implications

The use of so-called W&I (Warranty and Indemnity) policies is increasingly common in M&A transactions in Italy. These policies, which originate from Anglo-American legal systems, allow the parties to transfer the risk of damage resulting from inaccuracies or breaches in the seller’s representations and warranties to the insurer.

There are two main types of W&I policies:

• Buyer-side policy: Covers liabilities arising from breaches of warranties by the seller. By using a W&I policy, the buyer can transfer the risk associated with the seller’s representations and warranties to an insurance company, thereby reducing financial exposure in the event of errors or omissions by the seller.
• Seller-side policy: Protects the seller from indemnity claims made by the buyer due to breaches of warranties by the seller. Traditionally, sellers are required to offer warranties for any damages or losses resulting from inaccurate statements, which can lead to disputes or compensation claims. The use of a W&I policy helps reduce or eliminate the risk of facing such claims, while also increasing the appeal of the deal to potential buyers.

Facilitating negotiations

W&I policies make it easier for the parties to reach an agreement. When a seller is able to transfer warranty risks to an insurance policy, lengthy and complex negotiations over liability for legal or tax issues become less likely. This speeds up the deal process, reduces legal uncertainty, and lowers transaction costs for both sides.

Increased competitiveness and liquidity

W&I policies are particularly advantageous for buyers looking to avoid post-acquisition risks that could compromise the transaction’s value. By offering greater deal security and predictability, these policies enhance competitiveness in the M&A market, encouraging investors to engage in higher-risk deals.

Hard staple vs. soft staple: Key differences

In large transactions, the hard staple approach is gaining popularity. With a hard staple, the seller approaches the insurance market early in the transaction. The selected insurer will work based on the virtual data room (or vendor due diligence) and will prepare an advanced draft of the W&I policy, which is shared with all bidders and becomes a key requirement for continuing negotiations.

Typically, this draft will be negotiated only with the preferred bidder, though in some cases insurers may engage with multiple bidders.

Since the hard staple requires significant time and resources, some sellers opt for the soft staple instead. In a soft staple, the seller provides bidders with a broker’s report prepared after a preliminary market survey. In this scenario, access to the broker and insurers is granted only once exclusivity is awarded to a bidder, and underwriting is based on the buyer’s due diligence reports.

The role of legal counsel

At first glance, it may seem that, with a W&I policy covering the most critical parts of a Sale and Purchase Agreement (SPA), the role of legal counsel becomes less central.

On the contrary, careful legal assessment is even more crucial to ensure that the limitations of the W&I coverage do not overlap or combine with contractual exclusions in a way that disadvantages one of the parties—whether buyer or seller. Particularly sensitive is the alignment between the legal due diligence and the “supplementary” due diligence typically performed by the insurer.

Therefore, a thorough legal risk analysis is essential, along with a clear understanding of how risk coverage is distributed between the W&I policy and the SPA. Only through coordinated negotiation of both the policy and the SPA structure can the desired risk protection be effectively achieved.