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As the Indian mergers and acquisition market continues to evolve and grow, transactions are becoming more complex. In acquisitions or investment transactions involving promoter-controlled entities, promoters usually stand behind their indemnity obligations by resorting to such measures as escrows, price adjustments or holdbacks and direct recourse against sellers. However, issues arise when sellers are either investment funds nearing the end of their fund life; when the target is owned by investors with no identifiable promoter, or in the case of non-recourse or limited recourse deals. Usually, the most efficient way to structure such transactions is through warranty and indemnity insurance (WII).

WII covers losses that may arise from any misrepresentations or breaches resulting from representations and warranties made and provided during an M&A transaction. WII is becoming increasingly popular and a number of M&As in India are witnessing structures built around it.

Usually, policies are either buy-side or sell-side. In buy-side policies, the buyer is the insured party, and the seller is usually not a party to the insurance contract. In the event of loss, the buyer will claim an indemnity directly from the insurer for any breach of warranties by the seller. If any risks are not covered by the policy, transaction documents should provide for direct recourse against the seller. Buy-side policies are more common.

In sell-side policies, the seller is the insured party, and the buyer is usually not made a party to the insurance contract. In the event of a claim, the sellers recover indemnity claim amounts to be paid to the buyer from the insurer. Sell-side policies are often taken out for transactions with multiple bidders to reduce risks and encourage competitive bidding.

Insurance policies require parties to undertake comprehensive due diligence and make full disclosure. The parties cannot withhold what they privately know, nor can they claim to be unaware of a material fact due to their ignorance, as held by .

The time for the payment of premiums must be agreed between the parties, that is whether the premium is to be paid at the execution or closing stages. Section 64V-B of the Insurance Act, 1938, provides that insurance cover will not take effect until the premium is received in advance. Therefore, careful planning of the closing of the transaction is necessary to ensure that risks are commercially covered as agreed in the transaction documents.

Insurance policies usually include retention amounts, which are the amounts the losses must exceed for the insured party to claim them from the insurer. The retention amounts are usually fixed at between 0.5% to 1% of the purchase consideration.

Indemnity insurance policies exclude fraud, misrepresentation, seller obligations such as non-compete obligations, forward-looking statements, risks identified during due diligence and knowledge-qualified representations.

There are a number of legal obstacles that discourage the widespread use of indemnity insurance. For example, under Indian exchange control laws, a resident buyer may indemnify a seller who is a non-resident, but this indemnity is subject to strict limitations. The indemnity amount cannot exceed 25% of the total consideration. It may only be payable for a period not exceeding 18 months from the date of payment of the total consideration. If the indemnity claim is outside such limits, prior approval from the Reserve Bank of India is required. To overcome these challenges, non-resident buyers may consider obtaining indemnity insurance either from Indian insurers or their foreign counterparts. There is a wider range of insurance policies in foreign markets, and they offer greater coverage. Such advantages make them an attractive option for non-resident buyers.

In conclusion, while indemnity insurance offers significant benefits in protecting the financial interests of buyers and sellers in M&A transactions, its usage in India is limited because of market conditions and legal challenges. However, with the right due diligence and a full awareness of legal restrictions, indemnity insurance will help to mitigate risks and restrict losses. This will ensure smoother transactions in the complex world of M&A.

Parag Bhide is a partner and Mitali Kshatriya is an associate at Bharucha & Partners.