How a recent UK Court decision may influence the interpretation of W&I policies in Italy

Background

A Warranty and Indemnity (W&I) policy is a specialist insurance product by which the buyer of a company or a business can insure against the risk that the target business is not in the state warranted by the vendor. 

Although the product has been sold for decades across several jurisdictions, case law concerning W&I policies is remarkably scarce. This leaves practitioners unguided by specific precedent and means that solving disputes between the parties may have to be done without generally accepted legal principles. 

Given the international footprint of insurers that offer W&I policies and the international investment strategy of many W&I buyers, W&I policy wordings are broadly uniform in different jurisdictions. Substantial uniformity of solutions in the market as to their interpretation would surely benefit the commercial success of this product. There is therefore merit in keeping an eye on foreign jurisprudence, to consider to what extent its position could be passported in our system.

Recently, the English Court of Appeal affirmed a decision of the Commercial Court which addressed certain principles of interpretation of W&I policies. Whilst commentators have called this decision “illuminating”, our view is that the judgment is not a surprise and instead helpfully demonstrates and confirms how we would expect such policies to be interpreted and operate.

In this note we briefly examine this leading English W&I case and compare it to a decision on a similar subject matter in an arbitration tribunal handed down a few years ago in Italy, where we had the opportunity of assisting a leading insurer.

The leading English case

The recent leading English case related to the acquisition by Project Angel Bidco Ltd. of Knowsley Contractors Ltd., a company engaged in construction services. Amongst the representations and warranties given by the Seller, one covered anti-bribery and corruption compliance (the ABC Warranty). The ABC Warranty was included in the SPA after the Buyer was made aware that the Target had been involved in inappropriate funding of charitable initiatives promoted by their most important clients, which made the risk of non-compliance with anti-bribery and corruption law particularly high.

The buyer took out a W&I policy in connection with this deal, under which the ABC Warranty was marked “covered” in the policy spreadsheet. However, the Policy also provided for a broad exclusion relating to breaches of anti-bribery and corruption compliance (the ABC Liability Exclusion).

After its acquisition, the Target became insolvent as a consequence of a scandal triggered by the mentioned illegitimate funding. The Insured reported a loss under the W&I policy caused by breach of the ABC Warranty. The Insurer declined the claim on the basis that the ABC Liability Exclusion applied.

The Insured issued proceedings against the Insurer, and claimed in court that:

• there was an inconsistency between the insuring provisions of the W&I policy whereby the ABC Warranty was marked “covered”, on the one hand, and the ABC Liability Exclusion (which excluded any cover for the warranty in question) on the other; and
• the inconsistency arose due to an “obvious mistake” in the drafting of the ABC Liability Exclusion, which the court should correct as a matter of construction.

In particular, under the ABC Liability Exclusion any loss was excluded “to the extent it arises out of … any ABC liability”. ABC Liability was 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.

The Insured said that “or” should properly have read “for”. If this change/correction were accepted, then the ABC Liability Exclusion would not apply, because the breach the Insured reported consisted only of allegations which had not given rise to any liability.

The court dismissed the Insured’s claim.

At a preliminary issue trial, the court considered that, in order to determine the scope of coverage, the starting point is the insuring clause which, in this case, provides that the underwriters shall indemnify the Insured for any loss covered by the Policy subject to the Policy’s terms and conditions.

The exclusion clause is one of the “terms and conditions of the Policy”, to which the Insurer’s obligation to indemnify is made subject. Therefore, the exclusions are set out to limit the scope of the obligations for which cover is otherwise provided according to the cover spreadsheet. On this basis, the Court found that the ABC Liability Exclusion was to be applied to the loss reported. As the ordinary meaning of the clause was not “inherently absurd or obvious nonsense” there was no room to “cure the error” and re-write the clause the way the Insured pleaded, even though the breadth of the exclusion did appear to take away the cover which was referenced in the warranty spreadsheet. The court observed that an ordinary insured is taken to have read through the Policy conscientiously in order to understand what cover they were getting. It is worth noting that the insurer also argued that there was no such ‘error’ and this interpretation was inconsistent with the evidence / factual matrix applicable to interpreting the language used. It was also briefly discussed whether Buyer knowledge of the relevant issue would defeat the claim. However, the court did not need to decide on these arguments given its above decision.

The Italian arbitration award

In 2021, arbitrators were called on to assess the insurers’ liability under a W&I policy taken out in connection with the purchase of a target company engaged in the energy services business (in particular, the operation, maintenance and contracting related to heating systems provided to residential customers). During the due diligence exercise, the Seller had informed the Buyer that the Target applied VAT to energy supply contracts at a reduced rate, based on the position that such contracts were subject to a preferential tax treatment available for energy saving programs.

The Buyer investigated the accuracy of this position. It obtained from the Seller the minutes of a tax inspection carried out on the Target by the Italian Tax Police (Guardia di Finanza) two years earlier. In those minutes, the Tax Police expressly stated that the application of the reduced VAT rate to the energy supply contracts complied with the relevant tax laws.

The question of the application of a reduced VAT was thoroughly considered by the Buyer’s tax advisors, who flagged that the legitimacy of such fiscal practices was debatable. In fact, they advised that, notwithstanding the favourable outcome of the assessment of the Tax Police, there was still a risk that in the future the Revenue Agency might reconsider the position, which, if modified, would give rise to a situation where the Target would be obliged to pay a considerable amount in respect of the unpaid tax payments as well as fines.

The sale and purchase agreement (SPA) subsequently signed between the Seller and the Buyer provided that the Seller’s liability for breach of the Seller’s representations and warranties was generally excluded in the event that the facts or circumstances constituting the breach of any of the Seller's representations and warranties were fairly disclosed in the due diligence exercise. The Seller’s representations and warranties included a fairly standard tax warranty.

The Buyer took out W&I coverage for this acquisition transaction. The policy’s terms and conditions included a standard exclusion for losses arising out of circumstances known to the Buyer. With reference to the tax warranty, the policy’s spreadsheet marked it as “partially covered,” with explicit mention that VAT issues were covered and with certain subjectivities not relevant to the case at hand.

Following the acquisition, the Target was served by the Revenue Agency with a demand for payment of several million Euros, for having wrongfully applied a reduced VAT rate to energy supply contracts.

The claim was reported under the W&I policy but dismissed by the Insurer on the grounds that the Seller’s liability was not triggered, since the loss originated from facts that were fairly disclosed during the due diligence exercise. The insurer also raised further grounds for denial of cover.

The dispute was brought before an arbitral tribunal. Even though the claim made by the insured was for the large part dismissed on the basis of other objections raised by the Insurer, the arbitrators found in favor of the buyer/insured on the issue of the application of the “fairly disclosed fact” exclusion of liability.

On this specific issue, it was determined that even though “the issue pertaining to the correctness of the application of reduced VAT was certainly known to the Buyer and had been discussed between the parties… this does not allow to conclude that any possible liability be excluded in respect of losses originated from this issue, since no specific exclusion was included in the Tax Warranty set forth in the SPA… nor in the Policy spreadsheet.”

In particular, the arbitrators considered that, in the face of the very clear awareness of a fiscal risk by all of the parties, if the Insurer had intended to exclude coverage, they should have provided either to carve out that risk from the partial cover in the Policy spreadsheet or set forth a specific exclusion.

Remarkable similarities, different but consistent approaches

Both in the case before the English Court and in the one considered by the Italian arbitration tribunal, the parties to the SPA were aware that there was a specific potential problem (with ABC in the English case, and with VAT in the Italian case) and the issue was transparently reported to the insurer by the buyer/insured in the W&I negotiation. 

However, while in the English case the Insurer resolved to exclude cover by means of a specific general exclusion, in the Italian case the Insurer considered that it might have relied on a standard general exclusion clause for “disclosed matters.”  

Both the English Court and the Italian arbitration tribunal posed themselves the same question: “how would a reasonable person with all the relevant background information conclude – by reading the policy – that Insurer and Insured had chosen to manage the risk?”

The English court considered that by means of a general exclusion specific to the issue in question the parties to the W&I policy had chosen to leave the risk with the Insured. 

The Italian arbitration tribunal, on the face of a generic knowledge exclusion, considered that the parties to the W&I policy had chosen to transfer the risk onto the Insurer.

The reasoning of the decision taken by the Italian arbitration panel seems – at first glance – to contradict the position adopted by the English court.  The key in our view is the specificity of the general exclusions. In the Italian arbitration, the insurer did not include a specific exclusion regarding the issue and as noted by the arbitral judgment, could not rely on the knowledge exclusion to cover all possible liabilities relating to the issue – it being implied that only a more expressly disclosed set of liabilities would be so excluded (for instance perhaps if it had been actually disclosed that the VAT arrangements were in breach, rather than there being a risk of such arrangements being in breach). In contrast, the wording of the general exclusion in the English decision was specific and addressed to the ABC issue raised.

However, ultimately, both rulings consider the crucial issue to be what an “ordinary insured” would understand by conscientiously reading the policy wording.

In the end, both decisions confirm the need to produce a contractual text that is as clear and simple as possible (and for that text to be conscientiously reviewed by both parties) and for insurers to be clear regarding the scope of both specific and general exclusions and their interaction with the buyer knowledge.