Warranty and Indemnity (W&I) insurance is a well-established risk transfer tool in the Pacific, providing deal parties with risk capital that facilitates and de-risks M&A transactions. These policies cover loss arising from a breach of warranties and insured indemnities, provided by the seller to the buyer under the sale agreement.
There is limited case law in Australia regarding the interpretation of W&I insurance policies. From experience, this is largely owing to a low volume of unpaid claims. Coverage disputes that are litigated are therefore uncommon. Stakeholders, including the insured, insurer and their respective advisors tend to be sophisticated parties that are legally qualified, technically savvy and have a sound commercial understanding of W&I policies. The reputational risk to insurers who wrongly decline claims is high, and parties tend to reach settlement without the need to litigate.
Notwithstanding, questions frequently arise in respect of policy response, interpretation and the expedient resolution of claims. There are a few cases which serve as precedent and provide significant insight and guidance on policy interpretation, effective claims management and resolution. We distil and discuss some key points to consider on the operation and effectiveness of W&I Policies, based on the case law below.
Wording your policy exclusions
Project Angel Bidco Ltd (in administration) v Axis Managing Agency Ltd (as representative of Syndicate 1686 at Lloyd’s of London) and other companies [2024] EWCA Civ 446
While this is a recent UK decision, it provides helpful guidance on policy construction and drafting considerations.
The buyer acquired a civil engineering and general construction services business. The transaction was insured under a W&I policy. The insured buyer submitted a claim to insurers for loss arising from a breach of warranties relating to Anti-Bribery and Anti-Corruption (ABC). While these warranties were marked as covered under the policy’s warranty schedule, there was a general exclusion that excluded loss that arose out of ‘any liability or actual or alleged non-compliance’ in respect of ABC Laws.
The insured sought to enforce a narrow interpretation of the general exclusion, limiting it to cases of actual ABC liability as opposed to allegations. The insured argued that there was a ‘plain contradiction’ within the policy wording, which stemmed from a mistake in the definition of ABC liability. The insured reasoned that no loss arising out of a breach of the ABC warranties (despite the warranty schedule marking them as covered) could be covered on reading and applying the exclusion literally.
The court concluded that there was no obvious error, and that the insurance contract was to be read as a whole, in a contractual context. It was not sufficient to demonstrate inconsistency between policy terms. The court appears to have given weight to the underwriting intent in recognising that the underwriters had a coherent and rational reason for wanting to avoid liability for losses arising out of ABC liability. Importantly, the court considered whether there was potential coverage for warranties that fell outside the scope of the exclusion as drafted. If some cover was available, it would undermine the argument around a plain contradiction between the exclusion and covered warranties.
Tip: It is important to scrutinise the wording of the general exclusions when negotiating these bespoke policies. The alleged drafting error in this case was the use of the coordinating conjunction ‘for’ instead of ‘or’ in the exclusion wording. Even small changes to wording can have material implications on the scope of an exclusion. One must also consider whether the scope of the covered warranties is materially broader than the subject matter of the exclusion, to afford some meaningful cover despite the relevant policy exclusion. To avoid ambiguity or potential conflict, one must consider the warranty schedule (listing the covered warranties) in conjunction with the general exclusions to ensure they interact effectively.
First recourse to the policy – Adequacy of limit – Efficient claims resolution
UDP Holdings Pty Ltd (subject to deed of company arrangement) (Rec and Mgr apptd.) v Ironshore Corporate Capital Ltd (No 2) [2019] VSC 645
This decision has continued to support advisors in advocating for insureds, reinforcing several settled principles on policy response, intent and interpretation.
The business acquired by the buyer, traded in milk and dairy products. It turned out that one of the key customers (based on revenue) had been overcharged for milk over an extended period. As a result, the financial position was much worse than what was represented to the buyer in their financial accounts. The business was ultimately sold by the buyer for a sum that was far less than their original purchase price of $62.5million. The insured buyer claimed a loss arising from a breach of the seller warranties including the financial/accounts warranties.
Adequacy of limit: A full limit loss ($25 million/ approx. 40% of the purchase price) was paid out under a W&I policy to the buyer for breach of the insured seller warranties. The overall loss ($30.85 million) as determined and accepted by the court, considerably exceeded the limit of liability under the W&I Policy. The insured established loss under its contractual entitlement to recover against the seller for a breach of warranties. This loss included the difference between the price paid by the insured and the real or fair value of the target business. Defence costs (which are relatively broadly defined under a W&I policy), also contribute to the overall losses incurred. While defence costs were assessed to be nil in this case, an insured would ordinarily also be entitled to claim defence costs under the policy in addition to their contractual entitlement to damages. These costs can often pile-up and erode a material chunk of the policy limit.
Tip: The preferred limit often turns on the insured’s risk appetite and premium costs. This case illustrates that insureds should be mindful of the adequacy of the insured limit to avoid exposure to uninsured losses, including defence costs.
W&I Policy – First port of call: In determining the insured’s entitlement to interest under s 57 of the Insurance Contracts Act 1984 (Cth) (ICA), the court assessed whether there was unreasonable delay by the insurer in granting indemnity. The court gave due regard to the policy clause which provided that the insured was not obligated to seek recovery of amounts from third parties (including the seller) prior to submitting a formal claim under their policy.
Tip: The insurer cannot compel the insured to first collect recoverable amounts before the policy responds. Note that this does not derogate from the insured’s duty to mitigate its loss. The insurer’s duty to indemnify the insured, however, is not dependant or conditional upon the insured’s duty to mitigate its loss under the policy and at law.
Unreasonable delays and interest: In quantifying the interest payable, the court considered whether, and if so from what date, it became unreasonable for the insurer to have withheld payment under the policy. The policy required the insurer to respond acknowledging or denying cover for the loss claimed within 20 business days of receipt of any requested information in support of the claim. The timeframe was not relaxed by the insured initiating claims against a third party for the same loss. Interest was therefore awarded by the court from the date when it was reasonably practicable for the underwriters to respond to the claim and confirm indemnity. The court maintained that the insurer could have agreed to indemnify the insured under the policy, despite the defence costs and recovered amounts being disputed.
Tip: Early notification and a well-substantiated claims submission which establishes the insured’s entitlement to an insured loss under the policy, protects the insured’s rights under the policy and at law. This does not prevent an insured from supplementing its submission and providing further evidence (including additional quantum evidence) in support of its claim, down the track.
No contractual entitlement, no insurance
Aftermarket Network Australia Pty Ltd v Certain underwriters at Lloyd’s subscribing to Policy No 6482/13(C)-13087 [2016] FCA 1402
The buyer acquired a company that carried out a franchised automotive service business. The transaction was W&I insured and covered the buyer for losses which included amounts that it was contractually entitled to recover under the sale agreement for a breach of seller warranties. A limitation provision in the sale agreement extinguished or reduced the seller’s liability in respect of a claim in circumstances where the buyer or any of its related bodies corporate, ceased to own or control shares in the target or have a direct or indirect ownership interest in the target. Post-acquisition, the buyer’s parent company sold the buyer to another entity and ceased to control the buyer and the target, triggering this limitation and extinguishing the seller’s liability. The insured did not have a contractual entitlement to loss under the sale agreement in the absence of the sellers’ liability. The result was that an entitlement to loss in respect of policy claims that were made, including a claim that was made prior to the change in ownership, was also extinguished.
The court considered, inter alia, the construction of the seller limitation provision and whether their liability had been extinguished. The court adopted a construction which gave a practical and workable operation to the provision as a commercial change of control provision. The benefit of the warranties and the anticipated insurance was only to be for the benefit of the insured if there was no relevant change of ownership or control. The sale of the buyer/insured entity by the parent resulted in a change of ownership or control so as to extinguish the seller’s liability. The insured could not have an entitlement under the sale agreement, without the liability of the sellers. As the seller’s liability was extinguished in the circumstances, so was the insured’s entitlement under the sale agreement and consequently the insured loss.
Tip: One must carefully consider the scope of the limitation provisions under the sale agreement and their implications to the seller’s liability for the purposes of the W&I policy response. The W&I policy did not respond in the absence of the seller’s liability and the insured’s contractual entitlement to loss under the sale agreement. It is important to identify limitation provisions that extend beyond the standard seller limitation provisions required by insurers and have the effect of extinguishing the insured’s right to make a claim under the policy. Where possible, these limitations should be specifically disregarded under the policy to preserve the insured’s right to claim under the policy.
We welcome your questions on interpretation and policy response. Our experts have managed large W&I claims and achieved settlements in excess of $30million for corporate and PE clients. We draw on our M&A, legal and insurance coverage experience in providing clients with strategic and technical advice on claims management/resolution.
