12 June 2019

Innovative use of warranty insurances in real estate deals: how they work

If you’re a real estate or property developer and want secure title in large transactions, now there's an insurance product that safeguards your interests.

Andrew QuartermaineGallagher guest blogger and mergers and acquisitions expert Andrew Quartermaine explains how warranty insurance can be applied to protect parties in real estate sales.

Five years ago the warranty and indemnity (W&I) product was used almost exclusively in private equity transactions. It has now become mainstream in private sale M&A and is increasingly used in real estate. This includes straight asset deals and real estate M&A deals, particularly where the transaction is arranged by way of a share/unit sale.

In addition, product development in the last 12 months has meant that it is now possible for fundamental warranties (such as title to real estate, title to shares, corporate good standing and authority of a vendor, among others) to be insured by way of a Fundamental Warranty policy.

A Fundamental Warranty policy is

  • separate from a W&I policy
  • for the full value of the transaction
  • reasonably priced.

This new product can be used as a standalone policy, or combined with a W&I placement for non-fundamental warranties (such as tax and general warranties).

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How does it work?

Here’s a hypothetical example of how a Fundamental Warranty policy might work for the sale of units in a trust owning $300M of commercial property, utilising both a Fundamental Warranty policy and a W&I policy for tax and general warranties.

  • Fundamental Warranties covering title to units and the underlying trust/trustee’s title to real estate (100% EV for unlimited duration i.e. the full $300M) – premium of $500,000.
  • Tax ($30M cap for 7 years) and general warranties ($30M cap for 2years) – premium of $240,000.
  • Total premium – $740,000.

The benefits of purchasing these two products include

  • it avoids the need for escrow/contingent liabilities
  • can reduce financing costs
  • improves pricing for distressed deals
  • can be used to replace warranties that vendors will not/cannot give: insolvencies or winding up a fund, eg
  • can be used where a vendor’s credit standing is impaired or where vendors are a disparate group
  • the Fundamental Warranty product can be used to support warranties if the purchaser on-sells the property.

Features of a Fundamental Warranty policy

  • Significant capacity is available so that the full value of the transaction can be insured. There is no maximum limit.
  • Premiums can vary between 10 and 25 basis points of the limit insured, depending on whether insurance is for real estate title, share/unit title or both. Insuring fundamental warranties under a W&I policy costs about 80 basis points.
  • Unlike a W&I policy, Fundamental Warranty does not require a warranty to be breached. In fact, it does not even need a warranty to be given for the policy to respond. This is because it focuses on underlying risks, such as a vendor not having title to the asset or its title being affected by rights of preemption. Other contingencies which might compromise ownership include restrictive covenants, incorporation issues or failure to comply with development approval requirements, among many more.
  • The product lasts for as long as the acquirer owns or has an interest in the property and/or the units or shares. With a W&I placement Fundamental Warranties are normally restricted to a maximum of 7 years.
  • A deductible/de minimis is not compulsory and can be tailored to meet a client’s needs (subject to satisfactory due diligence in relation to the asset/transaction).
  • For an additional premium, the policy can also be used to cover ‘red flag’ issues discovered during due diligence. These would be excluded from any W&I placement.

Want to know more?

Call us on 1800 240 432 to speak to one of our friendly Professional & Financial Risks team to discuss your insurance needs. Alternatively,complete the form on the right and we'll get in touch at your preferred time.

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