W&I insurance: Key lessons from recent case law

Recent case law has highlighted the importance of understanding how a buyer on a share or asset sale has valued the target business and the clear drafting of exclusions. This blog considers the key takeaways for both warranty and indemnity (W&I) insurers and insureds.

Valuation

Under English law, contractual damages on a warranty claim are based on the difference between the share value as warranted and the actual share value. So how a target business is valued can affect the damages awarded.

Where a breach of warranty will have a recurring effect on earnings (for example, the breach relates to the loss of a key client), damages will often be multiplied by the relevant multiplier used when valuing the business. On the other hand, where there is no recurring effect on earnings, damages are likely to be assessed on a pound-for-pound basis. As such, evidence showing how or if a multiplier was originally applied or how similar items to those at the centre of a claim were dealt with will be useful when determining whether a breach has caused loss, and if so, quantifying damages.

The case of Finsbury Food Group Plc v AXIS Corporate Capital UK Ltd & Ors [2023] EWHC 1559 (Comm) illustrates this. The buyer had fixed the purchase price by reference to 1x sales, and so, if there had been a breach which in principle had caused loss, damages would have been assessed on any reduction in sales. If the buyer had, however, based its valuation on an EBITDA figure times a negotiated multiple, then it might have been awarded higher damages in the event of a successful claim. The courts will also consider what the parties would have done if the true position had been known at the time of the sale. Here it was held that the buyer would have paid the same purchase price regardless of the information received in respect of the alleged breach and so, even if a breach had been established, no loss would have been suffered.

W&I insurers are advised to seek evidence supporting the basis of valuation early in the underwriting process, as well as keeping an eye on what (if any) changes are made to the purchase price as the transaction progresses. Insureds should keep and maintain evidence setting out what they have considered and how they have approached valuing the target. 

Clear drafting of exclusions 

Exclusions provide important protection to W&I insurers so insurers should take care to ensure that any exclusions in the W&I policy are accurately drafted to capture their intentions. Clear exclusions also benefit insureds by providing a clear scope of what is or is not covered by the policy.

The disclosure exclusion 

A disclosure exclusion in a W&I policy or sale and purchase agreement (SPA) excludes from the scope of a warranty claim information which has been disclosed in accordance with a defined standard of disclosure. A common standard used in both W&I policies and SPAs is "fairly disclosed in the Disclosure Letter with sufficient details to enable a reasonable buyer to identify the nature and scope of the matter disclosed". Insurers will prefer a wider standard but an insured will want to limit this so that the threshold for triggering the exclusion is as high as possible. Insureds should however seek to ensure that the wording of the disclosure standard in the W&I policy matches that in the SPA to reduce the risk of claims which are valid under the SPA not being covered by the policy.

Interpretations of the standard will be fact specific. For example, the inclusion of a document in a data room might not be enough by itself to meet the disclosure standard (especially if several documents need to be read together to understand the relevant risk). In Infiniteland Ltd v Artisan Contracting Ltd [2005] EWCA Civ 758 (Infiniteland), an accounts warranty was held to have been breached. Files with enough information to flag the error, although not explicitly, were sent to the buyer's accountants who then discussed the matter with the sellers but did not raise it with the buyer. The warranties were given "save as set out in the disclosure letter" and it was held that the standard of disclosure had been met. The result would likely have been different if the agreed standard of disclosure had been higher, for example, "sufficiently full, accurate and clear to enable the [p]urchaser to have a complete understanding of the circumstances".

The knowledge exclusion 

A W&I policy will usually state that a claim cannot be brought where there was prior knowledge of the risk. This knowledge exclusion excludes knowledge that the buyer or specific named individuals in the buy-side team have before signing or closing. SPAs may, however, take the opposite approach and state that knowledge is no defence to a warranty claim. There may be enforceability issues with this approach but insureds should again be aware of any potential gap between liability under the SPA and coverage under the W&I policy. What counts as prior knowledge under a W&I policy varies: most policies now state that the standard is actual knowledge of a breach, but it can be wider and capture knowledge of a fact, matter or circumstance giving rise to a breach. A buyer will want to limit the standard as much as possible (i.e. to actual knowledge of named individuals) but sellers and insurers will prefer a wider standard.

In Infiniteland, the SPA stated that an "investigation made by [the buyer] or on its behalf into the affairs of" the target group would not affect its rights in the event of a warranty breach unless "such investigation [gave the buyer] actual knowledge of the relevant facts or circumstances". Comments in the leading judgment suggested that, while the buyer's advisers were aware of the issue, their knowledge could not be imputed to the buyer and so the carve-out did not apply. Although agreeing with the leading decision overall, one judge disagreed arguing the knowledge of an agent employed to carry out an investigation should "amount to actual knowledge in the purchaser" and that to hold otherwise would mean that a seller would be liable if that agent failed "in his contractual duty to the purchaser". The knowledge exclusion in a W&I policy will however typically be triggered only by actual personal knowledge of the relevant buy-side individuals (and not their constructive knowledge, or the actual knowledge of the buyer's advisers).

Specific exclusions

In addition to these general exclusions, W&I insurers typically exclude specific risks via targeted exclusions in the W&I policy (referred to as specific exclusions) and will often mark their coverage position in respect of each specific warranty in a cover spreadsheet attached to the W&I policy.

In Project Angel Bidco Ltd (In Administration) v Axis Managing Agency Ltd & Ors [2024] EWCA Civ 446 two key issues were considered: firstly, the drafting of the anti-bribery and corruption (ABC) exclusion and secondly, the relationship between the cover spreadsheet and the specific exclusions.
Regarding the ABC exclusion, the wording of the W&I policy stated that the insurer would not be liable for Loss (as defined in the policy) arising out of "any liability or actual or alleged non-compliance by any member of the Target Group or any agent, affiliate or other third party in respect of Anti-Bribery and Anti-Corruption Laws". The W&I policy's cover spreadsheet marked the relevant ABC warranties as "covered".

The insured argued that the ABC exclusion should have read "any liability for actual or alleged non-compliance" and that this would cure the (apparent) contradiction between the ABC exclusion and the cover spreadsheet. However, the Court of Appeal (by a majority) held that there was no drafting error because:

• the mistake was not common to both parties; from the W&I insurers' perspective, there was a "coherent and rational explanation" for the drafting;
• some of the relevant warranties could be breached in ways that did not fall under the exclusion; and
• even if there was an obvious error, there was no obvious cure as the mistake could be in the cover spreadsheet or the ABC exclusion.

Although the court found in favour of the W&I insurer here, this was, again, fact specific. W&I insurers and insureds should always take care to ensure policies are consistent throughout and that any wording reflects the agreed position as neither party benefits from uncertainty.

Concluding thoughts

The key messages to remember from these cases are that parties to a W&I policy should have a sound understanding of the target and its valuation, while also ensuring that drafting, especially of exclusions, is clear and consistent throughout the W&I policy. While parties will be under time constraints and commercial pressures during underwriting, keeping these thoughts in mind will put them in good stead if there is a warranty claim.