Corporate Law in Bite Size Chunks: Knowledge qualifiers on M&A transactions to limit liability

Although this may be reassuring to a buyer, as it knows that the seller will be forced to disclose everything it knows, such phrasing can have significant consequences for both liability and disclosure. This is particularly tricky in the context of large and/or complex businesses with a corporate seller, where there can be debates over what is the scope of the "seller's knowledge" and what happens if information is known by a remote part of the organisation, but has not filtered through to central management. This therefore affects how one goes about producing a disclosure letter, which is used to qualify the warranties.

A buyer's willingness to accept knowledge qualifications will be subject to considerations, such as:

• the parties' respective bargaining power, which is used to decide who takes the risk of "unknown risks";
• the buyer establishing a comprehensive understanding about the business and who has what knowledge within it;
• the nature of the warranty (e.g. speculative or future-facing matters);
• which individual's knowledge is to be counted as the "seller's knowledge"; and
• what process such individuals go through to check what needs to be disclosed and the extent that they give the buyer the necessary legal comfort to show that they have done this.

Market practice and legal drafting trends

Modern drafting increasingly requires sellers relying on knowledge qualifiers to demonstrate that they have made reasonable enquiries. This often includes consultation with the company's directors, professional advisers, and legal counsel. This shifts the burden of proof and narrows the scope of acceptable ignorance.

That said, the broader market trend is for buyers to increasingly reject knowledge qualifications, so that the risk of the unknown sits with the seller. This eliminates the vagueness inherent in knowledge qualifiers.

The rise of warranty and indemnity insurance in the UK M&A market

Liability under warranties is increasingly backed with a warranty and indemnity insurance policy ("W&I"). These policies, usually taken out by the buyer, effectively transfer liability for warranties and indemnities under an SPA to the insurer as sellers often negotiate nominal liability caps (often as low as £1). Insurance can be particularly advantageous for both a buyer and seller as it:

• takes stress off a seller when giving warranties;
• takes away the buyer's concern about a seller's credit strength and ability to satisfy warranty claims;
• avoids a buyer having to sue a seller for a meaningful sum when the seller may be working in the buyer's group post-completion;
• allows the buyer to "improve" on its warranty cover via the insurance, for example via "knowledge scrapes". This means that the insurer covers the warranties as if any seller knowledge qualifiers have been removed or to agree money and claim period limits under the insurance which are longer than those within an SPA; and
• takes some of the heat out of the debate over the warranties between the buyer and the seller as the insurer is able to take a more statistical risk-based approach to the assessment of risk. 

Nevertheless, insurers will still only cover unknown risks. They will want confirmation that the deal team of the person or entity taking out the insurance is not “actually aware" of any breach of warranty when the insurance is taken out. For these purposes, "actual knowledge" typically excludes constructive or imputed knowledge.  

UK M&A market trends and strategic takeaways

Whilst exact percentages of W&I policies being taken out vary by sector, W&I insurance is now standard in mid-to-large cap deals, particularly in private equity exits, carve-outs, and cross-border transactions involving tax or regulatory complexity. Knowledge scrapes are increasingly accepted, though they demand higher premiums and rigorous diligence. Increasing regulatory scrutiny is also reshaping deal structures, making clear and enforceable warranties more critical than ever.

Sector-specific nuances also influence how certain matters are carved out from coverage or addressed through bespoke insurance solutions. As a result, buyers and sellers navigating their transactions must pay careful attention to market norms within the relevant sector, as well as the negotiation of bespoke terms to manage deal-specific risks.