Interpreting W&I Policies – to exclude or not to exclude, that is the question…

It is unusual for Warranty & Indemnity (W&I) insurance disputes to reach the courts; however, we have now seen two such cases do so in relatively quick succession.  The Commercial Court handed down a judgment in Finsbury Foods¹ over the summer (see our briefing here), in which it considered the issue of whether there had in fact been a breach of the relevant warranty giving rise to an (insurable) loss. Now, His Honour Judge Pelling, in his judgment on a preliminary issue in Project Angel v Axis Managing Agency,² has provided guidance on another common and important issue, namely, whether losses arising out of a breach of a certain SPA warranty have been "excluded" under the W&I policy. The judgment provides a stark reminder of the importance of considering the exclusions in such policies extremely carefully.  In this case, the purchaser of the W&I policy was unable to rely on an appendix to the policy which indicated that the warranty in question was "covered", as the court deemed the policy, when considered as a whole (including the relevant exclusion clauses in the body of the policy), excluded cover for that specific SPA warranty. 

This case involved a buyer-side W&I policy, which related to the purchase of a civil engineering and general construction services business in November 2019 for approximately £16 million (albeit that liability under the W&I policy was capped at £5 million). 

The buyer alleged that certain of the warranties relating to the target company's compliance with anti-bribery legislation had been breached as a result of the target company's conduct (which is the subject of a police enquiry and is confidential).  The Claimant argued that this had caused the target company to be placed into liquidation and the Claimant itself to enter administration. 

The exclusion clause in the policy read:

"The Underwriters shall not be liable to pay any Loss to the extent that it arises out of…any ABC Liability".

The definition of "ABC Liability" read:

"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" (emphasis added). 

In his judgment, His Honour Judge Pelling considered that the definition of ABC Liability appeared to include three different species of liability:

"(i) Any liability … in respect of Anti-Bribery and Anti-Corruption Laws;

(ii) Any … 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; and

(iii) Any … actual … 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."

However, an appendix ("Appendix C - Cover Spreadsheet") to the policy listed the SPA warranties that were covered (or partially covered) under the policy - that list included a reference to a "bribery and corruption" warranty, which was recorded as being "covered".

As part of the preliminary issue hearing, the judge was required to consider two key issues in relation to the construction of the W&I policy:

1. Had there been a mistake in the drafting of the exclusion clause which the Court needed to correct? If corrected, the Claimant would be covered under the policy for the breaches of warranty which they alleged. The Claimant argued that there was an obvious mistake in the policy's definition of ABC Liability: the first occurrence of the word "or" should have been "for" and therefore the scope of the exclusion was confined to limbs (ii) and (iii) above (i.e. the exclusion only applied to actual or potential third-party liabilities, and did not apply to direct losses suffered by the Claimant such that coverage for limb (i) above was not excluded under the policy). The Defendants argued that the exclusion policy for "ABC Liability" as drafted was effective and should be construed as covering limbs (i), (ii) and (iii).
   
   
2. How did the exclusions contained within the main body of the policy interact with the appendix to the policy which listed the various SPA warranties that were covered by the policy (including warranties relating to bribery and corruption)? The Claimant contended that if the Defendants were right on Issue 1, then that would render the policy self-contradictory given that the applicable anti-bribery and corruption warranty was marked as a warranty which was "covered" in Appendix C. 

Importantly, if the Defendants were successful and the judge accepted their construction of the exclusion clause, the claim would be dismissed. 

The judge found for the Defendant insurers on both Issues, on the basis that a reasonable person, namely, "a person in the shoes of the insured claimant" would have interpreted the "bribery and corruption" warranty to be excluded from cover under the policy. In so doing, the judge made clear that: 

1. The framework principles that apply to the construction of an insurance contract (including any W&I policy) are the same as those that apply to the construction of any other contract. Accordingly, the "mistake" doctrine applies to contracts of insurance in the same way as it does to any other contract. In considering the Claimant's contention that the first "or" in the policy's definition of ABC Liability should have been "for", the judge found that there was no obvious error in the drafting, nor could it be said that the language was "obviously garbled". The judge was of the view that the three species of liability that he considered to fall within the definition of ABC liability each made clear sense, when read together with the insuring clause (which contemplated loss being suffered either directly by the Claimant or as a result of the target company having to pay a third party), and the other provisions of the agreement. 
   
   
2. The W&I policy must be considered as a whole. Most standard W&I policies will include an appendix which will list the "included" warranties, i.e. those SPA warranties that are covered by the policy.  The W&I policy in question was a fairly typical policy, with a schedule, followed by the detailed policy wording and then various appendices.  In this case, whilst there was an apparent conflict between the front end of the policy and Appendix C, the judge found that an ordinary policyholder would consider the warranty in question to have been excluded. In making this finding, the judge noted (amongst other things) that the appendix opened with a provision which stated that "Notwithstanding" the inclusion of a particular warranty in the spreadsheet, "certain loss may be excluded from cover pursuant to [the relevant exclusion clause]".  While the judge acknowledged that a "commercially sensible approach" would have been to mark the warranty in question as "excluded" in Appendix C, that did not mean that the insurers' proposed construction of the policy was wrong.

The decision is a helpful reminder that a W&I Policy must always be read (i) as a whole; and (ii) from beginning to end. Any warranties which are marked as "covered" in an appendix to the W&I policy will need to be considered against the backdrop of the relevant exclusion clauses contained in the "body" of the policy.  When negotiating W&I policies (which invariably involves the exchange of multiple drafts), practitioners will need to pay careful attention to any additions or amendments to the exclusion clauses - both from a substantive point of view, and in order to ensure consistency with the other provisions/sections of the W&I policy.