Tech M&A risks – W&I, contingent risk and cyber insurance coverage

M&A in technology companies are not structured like all other corporate acquisitions. This is because the assets that make up the value of the respective tech company are not comparable with those of traditional business models. This also means that there are special risks to consider in terms of insurance coverage: Risks in tech companies are not usually in the tangible assets, environmental pollution or production machinery. Instead, it is a question of intangible risks arising from copyright infringements, patent and licence infringements and data protection breaches. These special features should be taken into account in particular in W&I insurance, which is still very much in demand, contingent risk insurance and cyber insurance:

1. W&I insurance

For several years now, W&I insurance has established itself on the German market as an extremely helpful insurance product for the preventive hedging of transaction risks, especially for tech companies, which covers warranties and indemnity declarations of the seller. In these times of persistently low interest rates, it is predominantly the buyers who use this type of W&I insurance to protect themselves against their own financial losses due to breaches of warranty by the seller. Only occasionally is the insurance taken out by the seller himself in the sense of a special liability insurance. Especially in the current economic situation, however, it is advisable for the seller in particular to consider the advantages of W&I insurance at an early stage and, if necessary, to agree on its conclusion with the buyer, because such a solution can lead to a real win-win situation for all parties: The seller has a strong interest on the merits in limiting its liability risk, and without the buyer enforcing a reduction in the purchase price for lack of contractual liability. However, the advantages of the transaction product also outweigh the disadvantages on the buyer’s side: Despite the comprehensive limitation of the seller’s liability (clean exit), the buyer receives comprehensive warranties with regard to the acquired target through the W&I insurance, with a focus on the intangible risks in the tech M&A area.

However, in order for the W&I insurance to realise its full added value, a number of legal particularities have to be taken into account: W&I insurance only covers unknown risks of the transaction; in this respect, it is crucial for the insurer that a comprehensive disclosure process takes place (disclosure) and that the buyer has dealt intensively with the risks as part of the due diligence: Due diligence should be carried out on the transaction in question with at least the same intensity and to the same extent as it would have been carried out in the context of a transaction without W&I insurance. It is also advisable to contact the relevant insurers at an early stage with the help of a broker or to keep them up to date with the current status of negotiations, because from the buyer’s point of view the liability regime depicted in the company purchase agreement must be negotiated not only with the seller but also, in the case of the traditional W&I product, with the W&I insurer. The main focus at this stage is to avoid liability/ or coverage gaps. In addition, since the outbreak of the pandemic, we have observed that W&I insurers are including comprehensive Covid 19 exclusions in their policies or are insisting on increased disclosure in connection with Covid 19-specific risks existing with the target. Given that the pandemic remains limited in scope, the issue of Covid 19 exclusions or increased underwriting disclosures will continue to be a hot topic.

2. Contingent risk insurance

W&I insurance reaches its limits in the case of specific risks that have been identified (i.e. known) in the course of due diligence, typically in the areas of tax or in the case of an impending or already pending asset-related legal dispute (such as from data protection violations). Typically, such identified risks, some of which have a low probability of realization but a high potential for damage as a result, represent a possible “dealbreaker”. A potential solution is offered by contingent risk insurance, which is still rather unknown on the German market and covers an identified risk in addition to W&I insurance or as a “stand-alone” product. However, in order for the identified risk to be accepted by an insurer, the insurers require a detailed preparation in advance, including a reliable quantification of the risk to be insured. This is regularly done by means of a specialist legal opinion, which is discussed with the broker and the insurer during underwriter calls.

3. Cyber insurance

For tech companies (and especially for those whose activities focus on IT/cloud solutions), the question of the adequacy of a corresponding cyber insurance policy should be a particular focus in the context of a transaction. The standalone cyber insurances currently offered follow a modular concept, which sometimes prove to be complex from a legal perspective. Depending on the needs of the policyholder, it can choose different coverage modules, either in relation to its own risks (“first party risks”) and/or in relation to the risk of becoming liable to third parties (“third party risks”).