Know your ABCs: Exclusions to insurance policies and how a single letter can reduce your coverage

Demonstrating that contractual interpretation is not a cure-all for unfortunate drafting, the Court of Appeal’s decision in Project Angel Bidco Ltd (In Administration) v Axis Managing Agency Ltd serves as a reminder to parties of the importance of reading insurance policy exclusions to the letter (literally).

Whilst the Court recognised that the relevant policy “appeared to give with one hand and take away with the other”, there was no “obvious” mistake in the drafting, and no obvious cure available. Accordingly, the policy exclusion prevailed and the insured could not recover.

Background

The claimant (the Buyer) entered into a share purchase agreement (SPA) to acquire a civil engineering and construction company (the Target). The SPA contained a typical suite of warranties, including that there had been no instances of bribery and corruption within the target company group.

The Buyer took out a W&I insurance policy (the Policy) with the defendants (the Underwriters) to provide recourse in respect of the warranties.

Following the acquisition, the Buyer claimed to have discovered matters that breached the bribery and corruption warranty, which (it said) had cost the Target a valuable contract and caused a loss. They sought to recover policy limits (£5m) from the Underwriters. 

What is warranty and indemnity (W&I) insurance?

When acquiring a business (whether by buying the shares in an existing company or the assets and undertaking that comprise the business), a buyer will expect the seller(s) to make certain statements of fact about the business, known as warranties.

In principle, if any of those warranties turns out to be inaccurate, the buyer will be able to sue the seller(s) for “breach of warranty” to recover damages. The amount recoverable if a claim is successful is, broadly, the difference between the value of the shares or business (as applicable) if the warranty had been true, versus what they are in fact worth if the warranty is untrue.

In some cases, one or more sellers may not be prepared to provide warranties, or may only be prepared to provide warranties if their liability is capped at a nominal amount (typically £1 on UK M&A deals). In these cases, so-called “buy-side” W&I insurance provides a solution for the buyer. In essence, the buyer takes out an insurance policy which pays out if there are breaches of warranty that are covered by the W&I insurance policy. If there is a breach of warranty, instead of claiming against the seller(s)/warrantor(s), the buyer can make a claim under the policy.

Buy-side W&I policies interact heavily with the underlying share or business sale agreement, particularly in relation to exclusions from coverage and claims thresholds. It is therefore critical to ensure that the terms of the policy and the sale agreement knit together properly. For this reason, it is common to negotiate a W&I insurance policy alongside the sale agreement to ensure they align properly.

It is worth nothing that “buy-side” W&I insurance policies can be contrasted with “sell-side” policies, which are taken out by a seller or warrantor to insure against the risk of a claim by the buyer. Sell-side policies are, however, rare, for reasons beyond the scope of this article.

The Policy

As is usual, the Policy included a cover spreadsheet listing each warranty provided by the sellers in the SPA, and stating whether it was “Covered”, “Excluded”, or “Partially Covered” under the Policy. The definition of “Insured Obligations” in the body of the Policy confirmed that the obligations insured under the Policy were only those marked in the Cover Spreadsheet as “Covered” or “Partially Covered”.

Whilst the cover spreadsheet marked the bribery and corruption warranty as “Covered”, the Policy contained an exclusion of loss arising out of any “ABC Liability”, defined as:

“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”.  

A drafting error?

The Underwriters denied the Buyer’s claim on the basis of the ABC Liability exclusion. The Buyer argued that the definition of “ABC Liability” contained an “obvious minor error”, and should have referred to:

 “any liability [f]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 Buyer said that reading made sense of the bribery warranty being “Covered” in the cover spreadsheet. The loss resulting from a breach of warranty claim would be the diminution in the value of the shares in the Target, not a liability arising from breach of anti-bribery laws. Therefore, it would not be excluded. The alternative was that the Policy would be self-contradictory and/or contrary to commercial common sense if the warranties were noted as covered, but all potential losses arising from them were excluded.

At first instance, the High Court found no contradiction in the drafting. The main reasons relied on were the following.

  • The definition of “ABC Liability” in the Policy was not inherently absurd or obvious nonsense.
  • An ordinary policyholder would have read “or” in the usual way, and would not have relied on the cover spreadsheet without considering at least the indemnification provisions and the definitions in the rest of the Policy.
  • The cover spreadsheet’s only function was to identify obligations for which “in principle cover is provided”, and exclusions in the Policy were only capable of applying to an obligation which had been noted as “covered” in the spreadsheet.  

The Appeal

The Buyer appealed to the Court of Appeal. They argued that:

  • there was an apparent inconsistency between the scope of insurance coverage in the Cover Spreadsheet on one hand, and the definition of “ABC Liability” on the other;
  • that apparent inconsistency was the result of an obvious error in the definition of “ABC Liability”; and
  • there was an obvious cure to the error, namely substituting “or” with “for”.

The Court agreed that there was an apparent inconsistency in the Policy, given that the cover spreadsheet suggested that breaches of the bribery and corruption warranties would be “Covered”. However, the Court held that the cover ostensibly granted was in fact entirely excluded by the ABC Liability exclusion.   

The Court also did not agree that there was an obvious error in the definition of ABC Liability. While accepting that the definition was not “a masterpiece of drafting”, Lewison LJ took the view that the inconsistency was not enough. If there had been an “obvious mistake”, it would need to have been common to both parties. Looking at the underlying transaction, from the Underwriters’ perspective, there was a “coherent and rational explanation” for formulating ABC Liability as drafted. 

This was all the more so because the Underwriters had (as is typical) agreed to exclude their right of subrogation and were therefore commercially motivated to restrict their liability further. In Lewison LJ’s view, this pointed against the idea that the Underwriters had made an obvious drafting mistake.

The Court also did not consider that there was an obvious way to cure the error. Rather, as Lewison LJ identified, there were at least two possible ways to resolve the inconsistency in the Policy: (1) replace “or” with “for” in the definition of “ABC Liability” (as the Buyer’s had argued); or (2) replace all relevant instances of “Covered” in the Coverage Spreadsheet with “Excluded”. While the Buyer’s approach would require fewer corrections, Lewison LJ was not persuaded that either was preferable over the other or could be clearly shown to be what the parties’ intended.

Additionally, the Court took some support from the header to the cover spreadsheet, which explained that:

“Notwithstanding that a particular Insured Obligation is marked as “Covered” or “Partially Covered”, certain Loss arising from a Breach of such Insured Obligation may be excluded from cover pursuant to clause 5 of the Policy”,

Therefore, at least to some extent, the exclusions in the body of the Policy (including the ABC Liability exclusion) appeared to be intended to take precedence over the cover spreadsheet. 

Conclusion

The Court of Appeal’s judgment serves as an important reminder to parties seeking the comfort of W&I Insurance Policies of the risk of relying on the summary coverage schedules appended to the Policies, without due attention to the exclusions in the body of the Policy.

It should be a warning to policyholders: you will be taken to have read through a policy conscientiously, so should be sure to read the exclusion clauses, literally, to the letter.  

It also highlights the risk of negotiating a W&I Insurance policy after the accompanying sale agreement or under time pressure. 

All practitioners should note the high bar to resolving an apparent inconsistency in drafting through the doctrine of interpretation. The starting point will always be the words on the page.

Read the full judgment.