When the buyer enters into a promissory contract for sale and purchase of a property under construction, he assumes an obligation towards the seller - to acquire the property - without being able to know the terms under which the property will actually be built or have visibility of the property’s legal documentation because it does not yet exist at that time.
In this situation, the buyer will have to base his expectations on the representations and warranties given to him by the seller as to the characteristics, conditions and other contours of the transaction and the “future” property that the seller promises to sell, and the buyer promises to buy.
There is uncertainty and risk associated with the buyer’s position in a promissory contract for the sale and purchase of a “future” property and a growing need for players in the real estate market to reduce the risks associated with real estate transactions. In view of these two factors, the use of insurance in this type of deal has become quite common.
Although W&I insurance (warranties and indemnities/representations and warranties insurance) is not new to the Portuguese transactional market, there is a growing trend towards its use, especially in real estate transactions.
W&I insurance provides cover, for the benefit of the insured - who will be the buyer - for the risks of a possible breach of the representations and warranties (in this case, the losses the insured party may suffer), i.e. cover for any losses that the buyer suffers if any of the representations and warranties provided by the seller prove to be false, incorrect or misleading.
In addition, the implementation of W&I insurance solutions could, in some cases, replace traditional guarantee solutions (escrow account, bank guarantees required by buyers from the sellers regarding the initial payments and deposits to be made, etc.), and the cost of implementation W&I insurance is much lower than the latter.
On the seller’s side, W&I insurance is an opportunity for the seller to transfer the risk of non-compliance to a third party (i.e. the insurance company), and limit (up to one euro) the liability that may be required of it for non-compliance with representations and warranties offered to the buyer. At the same time, the buyer is given a guarantee of solvency/substance in relation to the entity that will bear this risk, which may be decisive in the buyer’s willingness to contract.
In addition, taking out a W&I insurance policy can accelerate and facilitate the negotiation process between seller and buyer, as the associated risk is transferred to the insurance company. The representations and warranties provided will also have to be negotiated with the insurance company, which will establish the terms of cover for them in its policy, while imposing greater or lesser limitations. This process will run in parallel with the negotiation of the promissory contract for sale and purchase.
If the promissory buyer requests financing to purchase the property, the existence of a W&I insurance policy may give more comfort in granting financing to the financing entity. This is because if there is a breach of the representations and warranties provided by the seller, compensation for the breach will be paid by making a claim under the insurance policy, rather than having to wait for the resolution of any dispute with the seller. In these cases, it may even be the financing entity itself that is the beneficiary of the insurance policy.
The costs of this insurance are typically divided equally between the promissory seller and the promissory buyer.
The term of this type of insurance will depend on the type of representations and warranties covered. Typically, the fundamental representations and warranties (title and capacity) and tax representations will benefit from a cover period of 7 years, labour and environmental representations and warranties from a cover period of 5 years and other so-called general representations and warranties from a cover period of 2-3 years. However, these periods can be negotiated with the insurance company in question.
It should be noted that this type of insurance only covers risks that are not known to the parties. It therefore expressly excludes coverage of any contingencies that have been identified during the process of legal, tax and/or technical analysis of the property (due diligence). If contingencies are indeed identified, there are other forms of insurance that cover specific risks already identified during the due diligence process, arising, for example, from tax contingencies, certain environmental problems, urban planning issues such as illegal construction, or issues related to title and the absence of liens or encumbrances over the property.
We recommend that, when negotiating a promissory contract for sale and purchase for the acquisition of a “future” real estate property, you should ask the lawyer dealing with the negotiations to discuss and analyse the possibility of taking out a W&I insurance policy as part of the negotiation.
This article was compiled with the expert contribution of Rita Calafate, PLMJ, a leading voice in real estate legal advisory in Portugal.
