REPRESENTATION AND WARRANTY INSURANCE IN M&A: NEW GROWTH DRIVERS FOR

INDIAN ECONOMY

16BAL113, 16BAL068, 16BAL121, AND 16BA013

Abstract

Obliterating the traditional approach of indemnification, the use of warranty insurance in

mergers and acquisitions of privately held companies has been seen with much popularity.
Warranty Insurance Companies are key strategic players, who promise to indemnify if buyer
meets out with any difficulty with the scheme of mergers at the later stage. Both strategic
acquirers and private equity buyers have gotten increasingly comfortable in using such
insurance for their acquisitions, providing meaningful benefits to both the buyer and seller in
an acquisition. M&A insurances facilitate the deal negotiations and cheapen dispute resolution

As a prelude, representations and warranties by a seller are key components of an acquisition

agreement and are often heavily negotiated by the parties. In a traditional M&A transaction,
the seller (or its shareholders) agree to indemnify the buyer (subject to caps, exclusions, and
time limits) for breaches of the seller’s representations and warranties. Often, the indemnity
has been backed by an escrow of a portion of the proceeds otherwise payable at the closing
(typically 10% to 15% for one to two years). The emerging use of representations and
warranties insurance is modifying or eliminating this traditional structure, wherein a harsh
long drawn and litigation involved. Also, PE players seek an exit opportunity on their
investment on a no or limited recourse basis. This in turn beneficial for PE and other investors
anchored on the smooth procedure for claims and effective incentive to seek maximum out of
their investment.

INTRODUCTION

In recent years, warranty and indemnity (W&I) insurance in M&A has been seen with much
fashion. Now, it is grabbing the attention of advisors, investors, and promoters at the
negotiation table in almost every merger and acquisition (M&A) transaction. It has a developed
jurisprudence in the western world and has been frequently being incorporated in transaction
in the US and other developed countries.

Over the last decade, Indian M&A has witnessed the entry of a lot of foreign investors and their
deals with Indian companies, in current updates we can see multiple deals of mergers,
acquisitions of shares and businesses in different sectors. For example, Walmart Inc.’s $16-
billion acquisition of e-commerce giant Flipkart, Amazon.com Inc. and Samara Capital
acquiring stakes in Aditya Birla Group’s retail chain. In the non-retail segment, Schneider
Electric SA’s acquired Larsen & Toubro Ltd’s electrical and automation business for $2.1
billion and Warren Buffett’s Berkshire Hathaway decided to invest $300 million in PayTm.1
These foreign investments embarked on through increasing Indian Economy coupled with
venturing into relaxing regulatory approach.

Increasing foreign investment and PE players in the market will enhance the Indian Economy
if proper purpose sought to be achieved by investor has been given priority. Therefore,
increasing representations and warranty insurance will repose confidence in investors,
especially Private Equity investors, as they seek an opportunity to exit on their investment in
limited period. It is not long before W&I insurance becomes standard practice for most M&A
transactions.

In such M&A deals, a peppering question also arises what can go wrong around sellers and
buyers or the contracting parties. In older stories of developed nations such transactions were
totally based upon escrow method which used to provide safer transaction to the buyer if seller
misrepresent the sale, but that method was very lengthy if we focus upon specifically Indian
Judicial system there is risk in regard of long- drawn litigation, so W&I insurance is a solution
to avoid these difficulties. W&I Insurance policies cover the losses for both the contracting
parties (seller & buyer). In type one which is Buy-Side policy, covers the losses caused to
buyers due to misrepresentation of the seller. Another one is Sell-Side policy in this insurance
a seller can protect himself from the losses incurred to him at the time of defending any claim
from the side of buyer. Every insurance company go through the proposed warranties,
representation, and indemnities and evaluate the company’s business and after that a report will
be issued along with the terms and policies and send to the parties who proposed for the
insurance and those parties can be either buyer or the seller or both.

In Indian scenario W&I Insurances there is very less number of insurance companies which
are providing such facilities. Because of that most of the W&I Insurances are not made in
Indian market that is why companies prefer overseas insurance companies. It is not only the
reasons for overseas transactions, but the Indian insurance market is also very costly in terms

1
Big Ticket Inbounds Deals Drive M&A in India, M&A Critique, https://mnacritique.mergersindia.com/big-ticket-
merger-and-acquisition-deals/ (28 Oct 11:40 P.M).
of their premium schemes even in small transactions W&I Insurances are not feasible for the
parties.

In India, parties are interested in W&I Insurances which is a better alternative to the long-
drawn litigation and costly ADR processes. However there is a probability that market will
increase shortly and whenever the demand will raise the cost of the premium will definitely
fall to make W&I Insurances more feasible to the market in terms of small as well as large
transactions.

When any M&A transaction occurs between the parties, both the parties have different interest,
a buyer expect more insured transaction and that is why he demands more warranties from the
seller but the seller does not want to disclose more of its documents before the deal get closed
and therefore submits very limited warranties before the buyer, therefore to align their interest
and to take over the gap W&I insurances plays a vital role. Even though there is no expressed
permission given by the Insurance Regulatory and Development Authority of India (IRDAI)
to W&I Insurance but in contemporary legal perspective provides it scope under commercial
liability insurance which has the approval of the Insurance Regulatory and Development
Authority of India.

REPRESENTATIONS AND WARRANTY

Representations and Warranties: Representations and warranties are the factual statements of
present or past fact that parties make and are included in most purchase agreements.2They are
used to expressly record the parties' understanding as to the conditions and facts under which
they are entering into the bargain. In the M&A context, they occupy a material part of the
purchase agreement. Typically, the seller provides a comprehensive set of representations and
warranties to the purchaser regarding the condition of the business to be acquired and how it
has been operated. The purchaser's representations and warranties are often limited to a few
general ones.3

The seller's representations are important because a prospective purchaser is unlikely to be able
to verify every detail about the seller's business.4 The seller typically has one motivation: to

2
Tina L. Stark, Another View on Reps and Warranties, 15:3 BUS. L. TODAY 49 (2006).
3
Andrae J. Marrocco, Negotiating Critical Representations and Warranties in Franchise Mergers and
Acquisitions - Part I, 36 FRANCHISE L.J. 107 (2016).
4
John C. Ramirez, Aaron M. Rotkowski & Irina V. Borushko, The Importance of Sellers' Representations in
M&A Transaction Purchase Agreements, WILLAMETTE-BANKER. TRANSACTIONS STRUCTURES INSIGHTS (2014).
limit the scope of its representations and warranties and the corresponding potential liability
flowing from them as much as possible.

Representations and warranties serve a number of important functions in M&A transactions

and are often subject to intense negotiations. First, they provide the purchaser with disclosure
and warranty as to the true state and condition of the business and its operations, assets, and
liabilities. Second, they allow the purchaser to address special considerations and concerns that
have arisen from its due diligence. Third, they allow the parties to allocate the risk of liability
(through termination or indemnity) for various matters associated with the business

WHAT IS WARRANTY

Warranty can be termed as an assurance to a buyer from a seller; it’s a kind of protection from
the seller to the buyer. It’s a contractual assurance breach of would result in a breach of
contract. The buyer can file a legal complain for the purpose of compensation, in order to get
the compensation, the buyer needs to prove the loss that has occurred to him and also the seller
would be liable only to those losses that are foreseeable as a result of the breach of warranty.
The purpose of warranty is to share and divide the risk and liabilities between the buyer and
the seller. It protects the buyer from incurring any losses due to the non-disclosure of any
information by the seller.

WHAT IS INDEMNITY

Indemnity is a type of contract in which it becomes an obligation of the party providing

indemnity to indemnify the loss of the other party. Indemnity can have said to be a promise to
the buyer on part of the seller to reimburse if any particular liability arises.

WHAT ARE W&I INSURANCE? ROLE

Basically W&I Insurances cover all the loss occurred because of a breach from the side of any
contracting party, policies can be of the nature of sell-side, buy-side and from both sides.

A sell-side policy, where the seller made claims if any loss occurs to him due to the breach of
warranty from the side of buyer, mainly it is a seller-insurer contract where insurer indemnifies
all the loss and cost to the seller for defence and cost for investigation occurred due to breach.

In a buy-side policy, where buyer made claims if any loss occurs to him due to the breach of
warranty from the side of seller, it is buyer-insurer contract, in such contract due to the limited
liability from the side of the seller because of the definitive documents, buyer cannot approach
seller for losses incurred to him so the insurer secured him from the losses and distressed
seller’s credit risk post-closing and help him in all the coverage related to warranties.

W&I Insurance are meant to be cover all the customary warranties but it does not include those
warranties which are related to money laundering, bribery and corruptions and such kind of
any issues which were illegal and in the knowledge of the parties, therefore it is a requirement
that all the definitive documents and indemnity clauses are given in it must correspond with
the policy, which helps in avoiding a state where a genuine claims raised under the definitive
documents do not suffer rejection.

Sometime insurer in their policies or schemes made parties responsible to bear some risk by
themselves, like

DUE DILIGENCE AND INSURANCE

The best knowledge and negotiation skills cannot stand up to unequal bargaining power and
the dynamics of a transaction. It has been the case for some that we are in a seller's market. The
harsh reality of recent trends is that sellers provide fewer representations and warranties,
shorter survival periods, and more materiality qualifiers than was previously the case. Not
surprisingly, there has been a significant increase in the use of representation and warranty
insurance in both the United States and Canada over the past decade (also as such products
have become more available and less expensive).

In recent times, due diligence and representations and warranties, among other things, are
curtailed by bidding processes and negotiation ultimatums imposed on the transaction by
sellers. It is not uncommon for sellers to require potential purchasers to detail their plans for
due diligence as part of the bidding process. This can spark a bidding war for the lightest and
fastest possible due diligence, thereby disadvantaging purchasers from having the opportunity
to identify issues that may be addressed in properly drafted representations and warranties.
Worse is the scenario where sellers impose strict constraints around due diligence, the amount
of information made available, and the timing for the process. Once again, this leads to a
situation where the purchaser is likely to have more risk and exposure under the final
representations and warranties included in the purchase agreement.

GENERAL BEST PRACTICES IN DRAFTING CLAUSES FOR WARRANTY INSURANCE

When it comes to drafting representations and warranties in the franchise M&A context (and
in some cases generally), a number of best practice principles apply, some of the most critical
of which are set out below.
A. TAILOR TO THE TRANSACTION

Representations and warranties ought to be deliberately and thoughtfully crafted and wrought
from the issues identified in the due diligence stage; the specific risks that the purchaser is
concerned about, based on the industry or operations of other franchise businesses; and
appropriate and fair negotiation.

Although the standard representations and warranties of a well-drafted general M&A

agreement go a long way toward providing an appropriate bargaining position between the
seller and purchaser, certain representations and warranties need to be customized to address
deal specific concerns of the parties. This facilitates more meaningful negotiations between the
parties, as opposed to posturing and power plays based solely on risk allocation.5 Standard
representations and warranties can, in fact, create problems for the seller when they are not
specifically customized for use in the specific context.

B. No Panacea

There can be a temptation to rely too heavily on representations and warranties in order to get
the deal done expeditiously. Representations and warranties should not be a replacement for a
proper due diligence process, which is necessary to fully understand the risks associated with
the business. It is a balancing exercise to maintain the momentum of the deal while conducting
meaningful due diligence at various stages of the transaction, together with addressing the
identified risks and concerns in the purchase agreement.6

C. Qualified and Limited

Sellers generally look to qualify and limit the many representations and warranties in a
purchase agreement. The most common qualifiers used to curb the scope and extent of
representations and warranties include (1) knowledge qualifiers, (2) materiality qualifiers, (3)
quantitative thresholds, and (4) look-back periods.7

 Knowledge qualifiers restrict the particular representation and warranty to the

constructive or actual knowledge of the seller, a subset of its representatives, or both.

5
Dawn Newton, Rebekah Prince & Les Wharton, Negotiating Key Provisions in the Agreement, IN MERGERS
AND ACQUISITIONS OF FRANCHISE COMPANIES 62 (Leonard D. Vines & Christina M. Noyes eds., 2014).
6
P. Thao Le, Reeves McGee & Breton Permesly, Basics: Franchise-RelatedM ergers and Acquisitions, IFA
LEGAL SYMPOSIUM 21 (2014).
7
Andrae J. Marrocco, Negotiating Critical Representations and Warranties in Franchise Mergers and
Acquisitions - Part I, 36 FRANCHISE L.J. 107 (2016).
  Materiality qualifiers are used to avoid technical and insignificant matters, e.g., "The
seller has complied with all applicable tax laws excluding minor breaches that are
unlikely to cause any material adverse effect."
 Thresholds are quantitative limitations that can be used to separate permitted or
insignificant matters from the factual statement, e.g., "Since the date of the financial
statements, the seller has not made any capital expenditure exceeding $10,000."
 Look-back periods are retrospective time limitations placed on representations and
warranties, used in the following way: "All advertising and marketing materials used
by the seller over the past five years have been provided to the purchaser . . ."

CURRENT TRENDS IN W&I IN ENGLISH LAW AND IMPORTANCE OF W&I

The price of the W&I insurance mainly depends on its purpose, which is to uncover the risks
which are unknown thereby following disclosure and due diligence process. Also, it should be
made clear that only the unknown risks are covered and not the known ones. In English law,
the initiating point in an insurance contract is the information and the knowledge the
policyholder has. Also, for the insurers it is easier to take the views regarding the coverage
position on the deals where the seller might have an element of residual liability on exit.8

Another Trend in the English Law is regarding the ‘Synthetic tax deeds’. It means the tax deeds
through which the seller has actually refrained from accepting the liabilities which are however
insured. Many times it has happened that there has not been any incentive given to the seller in
order to negotiate the deed, as a result of which there comes the burden on the insurer as to
negotiate the limiting provisions, which is actually not the real job of an underwriter on an
insures transaction.

Another issue faced by the hefty transaction is that of Split Exchange and Completion. In this,
the market for insurance suffers from the incidents arising from the period in between the
exchange and completion and sometimes even after the completion. This problem can be
limited by the way of maintaining the disclosures as a concern that the purchaser would be
barred to claim any breach of warranty.9

Another trend is in benefit of the sellers, where the seller qualifies the warranty to his own
knowledge language. But this thing somewhere depends on the insurer as sometimes he may

8
Max Hyatt, Warranty and Indemnity Insurance: Proliferation of Moral Hazard or Legitimate Risk Mitigation
Tool, 51 U.S.F. L. REV. 127 (2017).
9
M&ATrends: Representations and Warranties Insurance https://www.goodwinlaw.com/publications/2018/03/m-
and-a-trends-representations, (26 Oct. 11: 40 PM).
disregard the knowledge under the W&I insurance Policies. Another major trend in the English
law is that in the W&I market, in the insurance contract there can be no self-insured retention,
i.e. nil retention.

Lastly, the recent past it has been found that there has been increase in the claims regarding the
W&I policies, mainly regarding the breach of tax, financial statement, employment, and IP
warranties.

In the global arena, there has been much focus on the W&I because of multiple reasons. Firstly,
insurance policies are powerful deals that can be helpful in bridging the gap between the parties
and thereby closing the deals. Then, the policy actually provides the clean exit to the seller as
well as simultaneously providing alternative to the purchaser.10 Just because of the nil seller
recourse there has been a conspicuous increase in the M&A deals. Insurance policies can be
helpful to the Private Equity investors as it can be useful in protecting the management team
from claims. Lastly, with the help of W&I, administrative burdens can be eased and also some
sort of certainty be provided to the buyer when he is making the claim, especially in case of
multiple selling Shareholders.11

WARRANTY AND INDEMNITY INSURANCE TRENDS IN INDIA

India is one of the biggest markets for allcompanies in all the sectors. In recent years India has
seen a lot of Mergers and Acquisitions be it cross-border or within India. In every transaction
there is risk associated with it, such as the risk related to warranty, there may arise breach of
any warranty which may result in loss to the buyer company or this may also result in reduction
of share price of the company. Another bigger risk factor that is associated with the mergers
and acquisitions is the Tax, may times large tax liability arise because of the mergers and
acquisition which the company doesn’t foresee and later suffer loss. To avoid these losses there
is warranty and indemnity insurance but this is the recent trend, before this there are cases
where the company suffered huge losses because of the not taking the warranty and indemnity
insurance.

If we see the recent trends in India than it can be seen that the liabilities that mostly arise out
of any mergers and acquisitions if the Tax liability. There are few set examples of the Tax

10
Epstein, Howard B.; Keyes, Theodore A. Representations and Warranty Insurance Comes of Age [Article] ,63
PRACTICAL LAWYER, 21-24 (February 2017).

11
John Baer, Mark Kirsch & Beata Krakus, Due Diligence on Franchise Systems, 101 IN MERGERS AND
ACQUISITIONS OF FRANCHISE COMPNIES (2014).
liabilities arising out of mergers and acquisitions in India. The Best example of this is the
Vodafone case,12 in this particular case, both the companies that are the Vodafone and the
Hutchison are not based in India. Facts of the case are such that the Vodafone acquired the
entire share capital of the CGP Investments (Holdings) Ltd a company based outside India and
which holds 67% of the shares in the Hutchison Essar Limited, a joint venture based in India
of Hutchison Telecom International Limited and Essar Group limited. After this acquisition
Vodafone holds 67% of the shares of the Hutchison Essar. On this whole transaction no tax
was paid by either of the companies as both the companies were based outside India and there
was no law which states that the companies based outside India have to pay tax on the
transaction of an asset that is lying in India. But the Income Tax Department served Vodafone
with a notice to pay a huge amount of tax which was not paid by Vodafone at the time of the
transaction.

Now, in this case, a huge amount of tax liability occurred after the deal got closed and Vodafone
alone had to bear all of the liability. Had there been any type of insurance regarding the liability
arising out of the transaction then the Tax liability of Vodafone would have been shared.

This case was one of the landmark judgments in the area of Merger and Acquisition Insurance
where it was felt that there is need to insure the transaction that happens in the Mergers and
Acquisitions. After this case parties entering into any type of Merger and Acquisition started
opting for the Tax insurance as a safeguard to avoid further liabilities arising out of tax, as in
the case of Vodafone.13 The reason for increase in the trend of Tax insurance in India is the
uncertainty in the taxation laws of India and treaties of India with other countries regarding
tax.

But there is huge problem with this trend in India as in India the Merger and Acquisition
transaction are tax insured, but they are not fully insured in the form of Warranty and Indemnity
insurance and therefore they are open to a lot of risk as that of the Vodafone. There are a lot of
issues because of which a company should necessarily opt for the Warranty and Indemnity
Insurance such as:

12
Hiten Kotak, Mergers and acquisitions: The evolving Indian landscape
https://www.pwc.in/assets/pdfs/trs/mergers-and-acquisitions-tax/mergers-and-acquisitions-the-evolving-indian-
landscape.pdf .

13
Rajeev V. Nayar, Legal Lessons From Mergers And Acquisitions In 2018, https://inc42.com/resources/legal-
lessons-from-mergers-and-acquisitions-in-2018/, (6 Nov. 11: 00 PM).
1. The risk associated with new jurisdiction, as now a days a lot of companies are entering
into cross-border mergers, but they are not aware of the risk associated with it and it gives to
the need for such type of insurance.

2. One of the major risks that are associated is the uncertainty in laws of a country, each
country has different laws and they are kept on changing as per the time. Especially in India,
which is a developing country we have seen a lot of changes in the companies’ law and the
taxation law. These changes result in arising of unknown liabilities on the companies which
were not present before the company entered into the transaction.

3. The judicial activism and strict interpretation of the laws can also be considered a risk
for the mergers that take place in the country and also cross border mergers. Companies incur
a lot of amount on the merger and sometimes they fail because of the strict rules that prevail in
the country. if we take example of India, every merger has to go through a specified process,
for example filing of application in the Competition Commission of India. This is a compulsion
for every merger or acquisition and because of this a lot of merger fails.14

CONCLUSION

With the advent of increased and more sophisticated M&A transactions, it is critical that
transaction parties have a solid understanding of the unique critical considerations that apply
in the context of an acquisition of a franchise system. These considerations shape the entire
transaction process and culminate in the negotiation and crafting of specific representations
and warranties. An interesting juxtaposition is created by the current seller's market; the
majority of representations and warranties in a purchase agreement are given by a seller in
favor of the purchaser, and yet increasingly sellers are curtailing and limiting the due diligence
and the scope of representations and warranties. The result is that purchasers are often less
protected and take on more risk than would otherwise be acceptable-potentially one of the
catalysts for the increased use of representations and warranties insurance. By using the best
practice principles described in this article, together with the discussion of underlying rationale,
tools of analysis, and informal checklists covering representations and warranties, parties and
their counsel will be in a better position to navigate an M&A transaction.

14
Sidharth Shanker & Angira Singvi, Warranty And Indemnity Insurance In India: An Evolving Concept,
http://www.mondaq.com/india/x/136834/Insurance/Warranty+And+Indemnity+Insurance+In+India+An+Evolvi
ng+Concept (4 Nov. 11: 40 PM).
In India, there is a lot of scope in the Warranty and Indemnity insurance as India is a developing
country and there are a lot of mergers and acquisitions that take place in the country, these also
include the cross-border mergers. These mergers need to be insured as some mergers are ought
to fail because of some or the other reason, the reason can be any regulatory or conflict between
the parties. Whatever the reason may be, it involves a huge cost and to cover the cost there is a
need for Insurance. Warranty and Indemnity insurance is one type of such insurance that covers
the liabilities that arise out of breach of warranties by the seller. Because of the unawareness
of the benefits of such insurance, these insurance are ignored by the companies when they enter
into a merger and therefore are open to risks. This insurance can play a vital role in the market
by covering the cost and also by providing stability in the market. These types of insurance are
the need of the Indian market.