Today we will focus on W&I insurance and its consequences for dispute resolution.

Warranties and indemnities are contractual safeguards integral to business transactions. While their seemingly straightforward content is a result of due diligence findings and lengthy negotiations between parties prior to the closing of a transaction, the disputes arising thereof are often not so simple. One way of strengthening the buyer’s position is employing W&I insurance.

According to a study performed by AIG, a steady increase in the use of W&I insurance over many years has underpinned increasing numbers of associated claims. Although the aim of such insurance is to satisfy the buyer’s claims upon a breach of W&I without initiating proceedings, disputes may still arise both against the insurer (for example if the insurer denies the buyer’s claims or disputes due amounts) as well as the seller (regarding claims not insured, seller’s fraud not covered by the insurance or insurer’s subrogation rights).

In that context, parties must be cautious and act informed when drafting arbitration clauses, both in the SPA and in the insurance policy. This is especially relevant since the buyer is usually not a party to the insurance policy, and the insurer is not a party to the SPA. Doubts also arise regarding the scope of the arbitration clause when a buyer needs to sue under both the insurance policy and the SPA for claims that are not covered by the policy.

The question is whether the insurer’s interest is always aligned with that of the parties, especially when performing the due diligence. The insurer acting as a second pair of eyes may disincentivize the buyer from performing thorough due diligence but also highlight the risks that the seller would rather see watered down. In addition, insurers will provide coverage strictly based on the buyer’s declarations of knowledge, which precludes the buyer from claiming for breaches of which the buyer was aware before the transaction. Concurrently, the insurer will push the seller for extensive disclosures to mitigate risks associated with misstatements and fraud.

Procedural issues may also arise. For example, typical tools used in arbitration, such as document production and cross-examination of witnesses, will require a different approach if the insurer acts as a respondent in the arbitration with no participation of the seller. This is due to the fact that usually all the relevant information and evidence which could be used by the buyer in its attempt to sue for warranty breaches is usually at the disposal of the seller, not the insurer. Moreover, arbitration clauses might need to incorporate wording on consolidation for the purposes of proceedings with multiple insurers under different policies.

by Karolina Czarnecka

Stay tuned for more M&A posts!