Escrow versus W&I insurance – navigating M&A risk with confidence
Understanding the differences between escrow and warranty and indemnity (W&I) insurance, and how each serves the interests of the parties involved, is key to getting the best protection in mergers and acquisitions (M&A) transactions. In many cases, escrow offers the more dependable option, thanks to its greater transparency, faster access to funds and more reliable protection, which can unlock trust between the transacting parties.
During an M&A process, few concerns weigh as heavily on buyers and sellers as the risk of post-completion claims for a breach of warranty or undisclosed liabilities. Both parties need reassurance that there is a mechanism in place to resolve any such issues fairly and efficiently. Traditionally, this has come through either escrow or W&I insurance.
Understanding the differences
Escrow involves setting aside a portion of the purchase price in a secure third-party account for a specified period following deal completion. This fund offers financial safeguards; if a claim meets the agreed conditions, the buyer can recover losses directly from the escrow account. No external party needs to assess or approve the claim, and the release of funds is governed solely by the terms of the sale and purchase agreement (SPA) and escrow agreement.
By contrast, W&I insurance (typically arranged by the buyer) covers certain claims for breaches of warranties and/or indemnities. Policies specify which warranties are covered, any exclusions and under what conditions the insurer will pay out. In the event of a breach, the buyer makes a claim against the insurer, and the insurer will, in turn, process the claim and decide whether any funds can be paid out (as per the terms of the policy).
Speed and certainty
One of escrow’s key advantages is immediacy. In the event of a valid claim, funds can be accessed by the buyer without delay. This provides the buyer with a high degree of certainty and control. There is no risk of waiting months for a contested claim to be settled and no need to incur legal or advisory costs to unlock the protection promised.
Conversely, while W&I insurance means the seller typically has access to deal proceeds immediately, any claims by the buyer must go through the claims process. This may involve detailed evidence requirements, negotiations over the policy scope and sometimes litigation. Even straightforward claims can be delayed due to procedural steps and the insurer’s own interest in minimising payouts. Buyers may be tied up in lengthy and costly dispute resolution, undermining the very protection intended.
Reliability and scope of coverage
Another key difference relates to reliability. W&I insurance policies, though comprehensive, typically include exclusions such as matters discovered during due diligence, forward-looking warranties, issues involving fraud, or any areas the underwriter deems too risky to cover. The cover may be much narrower than that warranted in the SPA.
Escrow, however, directly reflects the terms of the underlying agreement. If a warranty is breached and the parties have agreed that it should trigger compensation, the funds are already set aside. There is no insurer to second-guess the nature of the breach or to dispute whether it is covered. This direct alignment with deal terms makes escrow more transparent and dependable for enforcing claims.
Alignment of interests
Escrow encourages a more balanced and accountable relationship between buyer and seller. Because the funds are held back from the seller’s proceeds and placed in escrow, the seller has a clear incentive to ensure that warranties are accurate, risks are disclosed and the deal terms are honoured. This promotes more open negotiations and encourages both parties to focus on risk management before closing.
With W&I insurance, which is typically buyer-led, the seller is effectively shielded from future claims. While this gives sellers a clean exit, it can dilute the incentive to disclose all material risks or engage in thorough due diligence. It may even lead to a false sense of security for the buyer, who assumes they are fully protected, but may later discover that key risks were never covered.
Practical challenges in enforcement
Enforcing a W&I insurance claim can be fraught with challenges. Buyers often face procedural obstacles that incur extra time and costs. These include disputes over policy interpretation, thresholds for loss and evidentiary standards. Even when a breach is clear, the insurer may require detailed documentation, expert valuations and legal opinions before agreeing to any payout.
For mid-sized deals, the cost of pursuing a claim may approach or even exceed the amount at stake. Buyers may abandon otherwise legitimate claims because the process is too cumbersome. Escrow avoids this problem by allowing claims to be resolved directly under the terms of the SPA, without involving third-party adjudication or lengthy validation.
Transparency and simplicity
In today’s complex M&A environment, simplicity has value. With escrow, parties agree on the amount, duration and conditions under which funds are released; terms that are visible to all parties and enshrined in the SPA.
Moreover, escrow is generally less expensive than W&I insurance, particularly when premiums, underwriting fees and advisory costs are taken into account. For deals where cost-efficiency and certainty are priorities, escrow offers a leaner and more transparent solution.
Building certainty and trust
In summary, escrow offers a simple and robust way to build certainty and trust in M&A deals. W&I insurance remains a useful tool, especially for larger or more complex cross-border transactions, or in cases where the seller is unwilling or unable to offer indemnities.
However, escrow provides immediate access to funds, reinforces seller accountability and simplifies the path to resolution in the event of a claim. In many cases, it delivers better alignment between buyer and seller, fewer surprises post-completion and a smoother overall experience for both sides.
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