It is common practice for buyers and sellers to take out Warranty and Indemnity insurance to protect against breaches of warranties given by a seller under a share sale agreement. The recent case of UDP Holdings Pty Ltd (subject to deed of company arrangement) (rec and mgr apptd) v Ironshore Corporate Capital Ltd in the Victorian Supreme Court (Court) provides important guidance on the circumstances in which an insurer will avoid making a payout to an insured party under a Warranty and Indemnity policy.
UDP Holdings Pty Ltd (Plaintiff) had entered into a share sale agreement with Esposito Holdings Pty Ltd (Seller) for the purchase of all of the shares in 5 Star Foods Pty Ltd (Company). After completion of the share sale agreement, it was discovered that the Company had overcharged one of its customers in an amount of approximately $9.3 million between 2012 to 2014. Accordingly, the Company’s financial position was much worse than what was stated in financial records provided to the Plaintiff prior to completion, meaning the Seller had clearly breached certain warranties under the share sale agreement.
The dispute between the Plaintiff and the Seller was referred to arbitration in accordance with the dispute resolution procedures outlined in the share sale agreement. At arbitration, an award was made in favour of the Plaintiff, however the Seller did not satisfy the award. During the course of the arbitration, the Plaintiff sought to make a claim under its Warranty and Indemnity policy with Ironshore Corporate Capital (Defendant), which was refused on the basis that the Plaintiff was not entitled to recover under the Warranty and Indemnity policy. The Plaintiff brought an action against the Defendant seeking payment under the Warranty and Indemnity policy, but the Defendant successfully obtained a stay of the proceedings until finalisation of the arbitration. After the arbitration, the Defendant still refused to make payment under the Warranty and Indemnity policy.
Issues determined by the court
The Plaintiff claimed that:
- the Defendant should be prevented from denying or contesting the facts underlying the award (Estoppel); and
- the arbitral award made in its favour for breaches of warranties by the Seller established that it had suffered loss and damage for the purposes of the Warranty and Indemnity policy, for which it was entitled to be indemnified by the Defendant; and
- it was also entitled recover the arbitration costs, and interest.
The Court held that, as the arbitration proceedings were conducted in relation to the share sale agreement and not the Warranty and Indemnity policy (and the Defendant was not a party to the arbitration), it would be unjust for the Defendant to be estopped from denying or contesting the Plaintiff’s insurance claim solely on the basis that an award had been made in the Plaintiff’s favour at arbitration.
The Court, after examination of evidence presented by experts appointed by both parties, determined that the Plaintiff had suffered loss in an amount of $30.85 million – which was in excess of the $25 million limit under the Warranty and Indemnity policy. The Defendant argued that it was not liable to make payment under the policy as the Plaintiff had commenced proceedings against the Seller and there remained a possibility that the Plaintiff could recover damages from the Seller. Accordingly, the Defendant argued that that Plaintiff had not yet suffered a loss for the purposes of the Warranty and Indemnity policy. The Court rejected this argument on the basis that the Defendant’s obligation to make payment under the Warranty and Indemnity policy should not be dependent upon the prior recovery by the Plaintiff of amounts owing by the Seller for breach of warranty. The Court noted that it may take considerable time and cost for the Plaintiff to recover compensation from the Seller and that not allowing the Plaintiff to recover under the Warranty and Indemnity policy would leave the Plaintiff exposed financially and would not be just and equitable. Accordingly, the Court ordered that the Defendant make payment in the amount of $25 million to the Plaintiff (being the limit of the policy).
Arbitration costs and interest
The Plaintiff sought to recover its costs of the arbitration from the Defendant on the basis that the Defendant had breached its implied duty of good faith by obtaining a stay of the proceedings and forcing the Plaintiff to incur further costs at arbitration. The Court held that there was no dishonesty or breach of faith by the Defendant. The Defendant was entitled to seek the stay, was not a party to the arbitration and was not responsible for any delays in the arbitration process. However, the Court held that the Plaintiff was entitled to receive interest under s 57 of the Insurance Contracts Act 1984 (Cth) on the basis that it was unreasonable for the Defendant to withhold payment given that the Plaintiff had provided advance notice of the claim and provided sufficient supporting documentation.
While it appears that insurers will not be bound by awards made at arbitration to which they are not a party, delaying payment under a Warranty and Indemnity policy may result in an obligation to make a substantial payment of interest.
Please do not hesitate to contact us if you require advice on Warranty and Indemnity insurance or the preparation of share sale agreements containing appropriate and extensive warranties.