Synthetic Warranties in W&I Insurance
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What Are Synthetic Warranties?
Synthetic warranties are a new concept which is gaining popularity. Unlike traditional warranties, synthetic warranties are not given by the seller in a traditional agreement but instead the W&I insurance policy “deems” the warranties given by the seller. The synthetic warranties are only contained in the W&I policy. This means that the insured can claim under the W&I policy as if the seller had given the warranties but wouldn’t be able to claim directly against the sellers. Therefore, the insured’s only form of recourse is via the W&I insurance policy.
Risks and Challenges
Synthetic warranties present significant challenges for W&I insurers. Most significantly, because the sellers are not giving any warranties, there isn’t going to be a rigorous disclosure process. The disclosure process (information about the target being disclosed to the buyer from the seller) is a key method for allowing the insured to know about the issues within the target which they then can’t claim for. Because there isn’t a disclosure process where synthetic warranties are given, there is a big risk for the W&I insurer that the insured will not know about a lot of issues that then become coverable under the W&I policy.
There are a few ways to negate this risk. Firstly, since W&I insurers are responsible for drafting the synthetic warranties, these warranties are likely to be very low risk and “vanilla”. This brings in a debate about whether synthetic warranties are actually beneficial for the insured. Secondly, the W&I insurer could require the seller to conduct a standard disclosure process against the synthetic warranties, however, this is unlikely to happen since the sellers are unwilling to give any warranties they are probably also going to be unwilling to conduct any disclosure process. The result is that synthetic warranties are currently very risky for W&I insurers and therefore very expensive to purchase.
Use Cases
There are some instances where a synthetic warranty W&I policy is required. For example, in public-to-private transactions which involves taking a public company private, the sellers are likely to be individuals or institutional sellers who have no day-to-day oversight over the target company. This means that it would be impossible for these sellers to provide warranties. Synthetic warranties can step in to provide some recourse to the buyer as if the sellers were able to give warranties.