Warranty & Indemnity insurance: A strategic imperative for M&A transactions in Kenya
- W&I insurance is poised to play a critical role in achieving the objectives of all parties involved in the rising M&A activity in Kenya.
- W&I insurance is important as a tool for mitigating risks and facilitating smoother, more secure transactions.
The Kenyan Mergers & Acquisition (M&A) market has witnessed a significant uptick in the adoption of Warranty and Indemnity (W&I) insurance, signalling a pivotal shift in how transactions are structured and executed. This seriously highlights the need to use W&I insurance as a tool for mitigating risks and facilitating smoother, more secure transactions.
W&I insurance plays a critical role in providing both sellers and buyers with added security, ensuring a clean exit for sellers while alleviating buyers’ concerns about the seller’s ability to honour warranty or indemnity claims post-transaction. As M&A activity continues to rise in Kenya, W&I insurance is poised to become an invaluable asset in achieving the objectives of all parties involved.
Historically, W&I insurance has been more prevalent in foreign-based transactions, particularly within regulated sectors such as insurance, banking, and private equity. While its adoption is gaining momentum locally, especially among private equity sellers, W&I insurance is still underutilised in purely domestic transactions. Yet, it offers substantial protection for parties involved in M&A transactions:
- For buyers: It provides reassurance that they will be compensated in the event of a breach of warranties or indemnities, reducing the financial risks associated with the transaction.
- For sellers: It allows for a clean exit, free from the lingering threat of future claims, enabling them to focus on new opportunities without the burden of unresolved liabilities.
However, to maximise the benefits of W&I insurance, it is crucial to integrate it early into the deal process. A comprehensive understanding of the target business, achieved through rigorous due diligence, is essential for both parties and the insurer.
This due diligence forms the foundation upon which warranties and indemnities in the Sale and Purchase Agreement (SPA) are drafted, ensuring that they are precise and tailored to the specific transaction. These carefully drafted warranties and indemnities then provide a solid basis for insurance coverage.
While W&I insurance offers robust protection, there are several challenges and considerations that parties must navigate:
Cost Implications: The cost of W&I insurance can be substantial, particularly in high-risk sectors where the likelihood of claims is higher. Parties must weigh the benefits of coverage against the associated costs.
Policy Limitations: Policy caps, deductibles, and exclusions may limit the overall protection afforded, making it essential to carefully assess the terms and conditions of the policy.
Impact on Deal Timelines: The insurance process, including the appointment of a broker, underwriting, policy negotiation, and integration into the sale agreement, must align with the broader transaction timeline. W&I insurance relies heavily on due diligence for determining coverage, and any delays in this process can impact the overall transaction timeline.
When deciding whether to include W&I insurance in an M&A transaction, several factors must be considered:
Firstly, Industry and Transactional Factors: The industry and size of the target business significantly influence the need for W&I insurance. Industries with complex regulatory frameworks or those characterised by higher risk profiles may benefit more from this coverage.
Secondly, Policy Scope and Underwriting: The scope of coverage is paramount. Parties should carefully evaluate the specific warranties and indemnities to be insured. A balanced approach, considering both comprehensive protection and reasonable exclusions, is essential. Thorough due diligence and comprehensive disclosures are crucial as they impact the insurer’s assessment of the risk profile.
Thirdly, Policy Terms and Conditions: The policy’s duration, typically ranging from 12 to 36 months, must align with the potential exposure period. Additionally, the agreed-upon deductibles and excess amounts will influence the overall cost of the insurance. A clear understanding of the claims process, including notification requirements and dispute resolution mechanisms, is vital for effective risk management.
Fourthly, Alignment with Transaction Objectives: W&I insurance should not be viewed in isolation but as part of a broader risk management strategy that aligns with the transaction’s overall objectives. Early integration and careful planning can help ensure that W&I insurance enhances, rather than complicates, the deal.
While W&I insurance offers substantial benefits, it is not without its challenges. The cost, potential policy limitations, and the need for alignment with the broader transaction timeline are factors that must be carefully managed.
However, for those who navigate these complexities with foresight and precision, W&I insurance can transform the way deals are structured and brought to life in Kenya. As more businesses recognise its value, it will likely become a standard feature in M&A transactions, driving a new era of secure and efficient deal-making.
Sammy Ndolo is the Managing Partner at Cliffe Dekker Hofmeyr (CDH) Kenya
