A buyer discovers a historic tax issue during due diligence. An environmental report identifies possible contamination at one of the target company’s sites. A significant customer dispute is already under way before completion.
These are very different from a problem that only comes to light after the acquisition has completed.
That distinction matters when warranty and indemnity insurance is being considered.
W&I insurance can provide protection against certain financial losses arising from breaches of warranties in a sale and purchase agreement. However, it is not generally designed to turn a known transaction risk into an unknown one simply because insurance is being arranged.
Where due diligence has already identified an issue, buyers and sellers need to decide how that specific exposure will be allocated. That may involve a contractual indemnity, a specialist insurance solution, changes to the transaction terms or the parties retaining some of the risk themselves.
Why known and unknown risks are treated differently
W&I insurance works alongside the warranties given in the sale and purchase agreement.
Those warranties are statements about the target business. They may cover areas such as accounts, contracts, employees, tax, intellectual property, assets, regulatory matters and litigation.
If a warranty later proves inaccurate and the buyer suffers a covered loss, a W&I policy may potentially respond, subject to its terms.
The position is different where the problem is already known before completion.
If due diligence establishes that a particular customer dispute exists, for example, there is no longer uncertainty about whether that issue is present. The buyer, seller and insurer can all see the exposure.
The transaction therefore needs to address that risk directly rather than assuming it will simply sit within the general W&I policy.
A simple example of an unknown warranty breach
Suppose a seller gives a warranty that there are no undisclosed material disputes with key customers.
Due diligence does not identify any concerns and no relevant dispute is disclosed.
After completion, the buyer discovers that a major customer had raised a significant complaint before the transaction and that the issue was not properly disclosed.
The buyer may argue that the warranty was breached.
Whether W&I insurance responds would depend on the policy wording, the warranty itself, the disclosures, the due diligence undertaken and the circumstances of the loss.
The key point is that the buyer did not enter the transaction already knowing about the issue.
A known risk needs a different approach
Now consider the same customer dispute appearing clearly during due diligence.
The buyer knows:
- Which customer is involved
- The nature of the allegation
- The potential commercial impact
- That the issue existed before completion
That risk can no longer sensibly be treated in the same way as an unknown problem that emerges afterwards.
Instead, the parties need to decide who will carry the exposure if the dispute develops into a financial loss.
This is where targeted transaction protections become important.
A specific indemnity can allocate an identified risk
An indemnity is often used where the transaction contains a particular known exposure.
Rather than giving a broad statement about the business, an indemnity can allocate responsibility for the cost of a defined matter if it crystallises.
For example, due diligence might identify:
- An uncertain historic tax treatment
- Existing litigation
- An environmental issue
- A regulatory matter
- A contractual dispute
- A known employment liability
The buyer may seek an indemnity requiring the seller to meet specified losses arising from that issue.
The drafting and commercial effect of an indemnity are matters for the parties and their legal advisers, but from an insurance perspective the distinction is important.
A general warranty deals with the accuracy of statements about the business. A specific indemnity deals more directly with an exposure that has already been identified.
Some known risks may have their own insurance solution
A known exposure does not always have to remain entirely with the buyer or seller.
Depending on the nature of the risk and the insurance market available, a separate policy may sometimes be considered.
Tax is a useful example.
If due diligence identifies uncertainty around a historic tax position, the parties may consider a contractual indemnity. In some circumstances, tax indemnity insurance may also provide another way of addressing a defined exposure.
Other known issues may require different specialist solutions.
The important point is that they need to be assessed individually.
A specific environmental exposure, for example, should not be assumed to fall within W&I insurance simply because environmental warranties appear in the transaction documents. The same principle can apply to known litigation, pension issues, regulatory concerns, product liabilities or cyber matters.
The right solution depends on what has been identified, how clearly the risk can be quantified and whether an insurer is prepared to underwrite it.
Due diligence helps define the boundary of W&I cover
Due diligence is not an obstacle to W&I insurance.
It is an important part of the underwriting process.
Insurers need to understand what the buyer and its advisers have investigated before deciding which warranties they are prepared to insure.
That may include reviewing:
- Legal due diligence
- Financial due diligence
- Tax reports
- Sale and purchase agreement wording
- The disclosure process
- Material contracts
- Employment matters
- Regulatory issues
- Property and environmental information
- Other specialist reports relevant to the target business
A well-investigated area gives the insurer a clearer understanding of the risk it is being asked to accept.
By contrast, a gap in due diligence can create uncertainty.
If an important part of the target business has barely been reviewed, the insurer may seek further information, limit the scope of cover or exclude the area from the policy.
Disclosure can change the insurance position
Disclosure is central to the relationship between the sale agreement and the W&I policy.
A seller may qualify a warranty by disclosing information to the buyer.
If an issue is properly disclosed before completion, the buyer enters the transaction with knowledge of it.
That can affect both the buyer’s contractual rights and how the W&I insurer approaches the risk.
This is one reason W&I insurance should not be viewed separately from the transaction documents.
The policy, warranties, disclosures and due diligence all need to be considered together.
Not every exclusion means the transaction cannot proceed
An insurer excluding a known risk does not necessarily mean the acquisition has a fundamental problem.
It means that particular exposure needs another answer.
The parties may decide to deal with it through:
- A specific indemnity
- A seller liability
- An escrow arrangement
- A retention
- A purchase price adjustment
- Additional due diligence
- A specialist insurance policy
- Another negotiated contractual mechanism
Which option is appropriate depends on the importance of the issue and how buyer and seller want to allocate the risk.
W&I insurance can still play a valuable role across the rest of the transaction even if one identified matter sits outside its scope.
W&I insurance still protects against uncertainty elsewhere in the deal
A business acquisition can contain both known and unknown risks at the same time.
Due diligence may identify one tax concern and an existing customer dispute, while many other warranties remain concerned with matters that neither party expects to become problematic.
A warranty and indemnity insurance policy may provide protection around covered unknown warranty breaches, while the identified tax and customer issues are handled separately.
This is often a more useful way to think about transaction insurance.
The objective is not to place every possible liability under one policy.
It is to understand where each material exposure sits and make a deliberate decision about who will carry it.
Known risks should be identified early
Timing matters because the available options narrow as completion approaches.
If a significant exposure is discovered late in the process, the buyer and seller may have limited time to investigate it, negotiate an indemnity or explore specialist insurance.
Early involvement allows the transaction team to establish:
- Whether the issue can be investigated further
- Whether the risk can be quantified
- Whether the seller is prepared to retain it
- Whether a specific indemnity is appropriate
- Whether specialist insurance may be available
- Whether the main W&I insurer will exclude the matter
- Whether the commercial terms of the transaction need to change
That discussion is much easier before the deal structure has become fixed.
W&I insurance should sit within the wider transaction strategy
The most effective transaction insurance arrangements do not begin with the question, “Can we insure everything?”
They begin by asking:
- Which risks are genuinely unknown?
- Which exposures have already been identified?
- Which warranties are supported by appropriate due diligence?
- Where has the seller made disclosures?
- Which risks can sit within the W&I policy?
- Which need a specific indemnity or another solution?
- Which risks are the buyer or seller prepared to retain?
Those questions create a clearer picture of the transaction than relying on the presence of a W&I policy alone.
Where an issue is already known, the focus should be on allocating that specific exposure properly. Where the uncertainty remains genuinely unknown and falls within the policy terms, W&I insurance can provide another layer of protection.
The strongest transaction structure is therefore not necessarily the one with the broadest insurance policy. It is the one where buyers, sellers and advisers understand which risks have been transferred, which have been retained and which still need a separate solution.
FAQs About Known Risks and W&I Insurance
Can W&I insurance still be arranged if due diligence finds a material issue?
Potentially. An identified issue may be excluded or dealt with separately while W&I insurance is arranged for other covered risks within the transaction. The effect will depend on the significance of the issue, the policy terms and the insurer’s underwriting.
Does one W&I exclusion mean the rest of the transaction cannot be insured?
No. An insurer may exclude a particular known exposure while providing cover for other warranties. The excluded matter then needs to be allocated through another insurance, contractual or commercial solution.
Can additional due diligence change how an insurer views a transaction risk?
It can. Further investigation may give the insurer a clearer understanding of an exposure and help determine how it should be treated. It does not guarantee that an exclusion will be removed, but incomplete information can make underwriting more difficult.
Can more than one insurance policy be used in the same acquisition?
Yes. A W&I policy can sit alongside a separate specialist policy where a particular exposure requires its own underwriting. The appropriate structure depends on the risks identified during the transaction.
Should known risks be raised with the W&I insurer before policy terms are finalised?
Yes. Identified issues should be considered as part of the underwriting and disclosure process so the parties understand what the W&I policy will and will not cover before completion.
