Mistake not established in determining scope of exclusion

The Commercial Court judgment in Project Angel Bidco Ltd (in Administration) v Axis Managing Agency Ltd [2023] EWHC 2649 (Comm) is the latest addition to a small but growing body of English case law regarding the operation of warranty and indemnity insurance (W&I) policies and claims made against such policies (see our articles on previous cases: Finsbury Food v Axis [2023] and Ageas (UK) Ltd v Kwik-Fit [2014]). Warranty and indemnity insurance is a popular M&A deal tool designed to transfer the risk and financial consequences of warranties given in the context of corporate transactions from the transaction parties into the insurance market.

In this case, his Honour Judge Pelling KC rejected the claim by a purchaser and insured (the Buyer) that the buyer-side W&I policy (the Policy) issued by the defendant insurers (the Insurers) contained an obvious drafting error which should be corrected as a matter of construction to prevent the Insurers relying on an exclusion clause to deny coverage.

The Court sought to apply principles of contractual interpretation as set down in FCA v Arch Insurance (UK) Limited and others [2021] UKSC 1 (the FCA Test Case) in deciding that: (i) there was no obvious mistake in the drafting of the breadth of the ABC exclusion, which therefore included alleged as well as actual liability; and (ii) viewed as a whole, there was no cover for breach of ABC liability warranties even though they were listed as covered in the face of an equivalently wide and explicit exclusion.

BACKGROUND

On 19 November 2019, the Buyer acquired the entire issued share capital of Knowlsey Contractors Limited (trading as King Construction) (the Target), which carried on business as a provider of civil engineering and general construction services mainly to local authorities and principally to Liverpool City Council. The sale was for £16.7m (the Transaction). The Transaction was concluded under a sale and purchase agreement (SPA) under which the sellers gave warranties which were then insured under the Buyer's W&I Policy (with £5m policy limit), with the sellers' liability for breach of warranty capped at a nominal amount under the SPA (save for fraud claims).

Post-sale, the Buyer discovered that the sellers were allegedly involved in conduct that contravened anti-bribery legislation. This alleged conduct was the subject of an ongoing police enquiry and the parties agreed that the details should be treated as confidential for the purposes of the trial.

The Claim

The Buyer maintained that as a result of the discovery of the alleged conduct, Liverpool City Council, being a major client of the Target, ceased or severely reduced the business it did with the Target. The sellers' failure to disclose the conduct resulted in a breach of warranty under the SPA causing the Buyer to suffer loss and damage as it had received shares in the Target that had a lower value than if the warranties had been true. The warranties alleged to have been breached concerned undertakings that the sellers:

• were not engaged in (or aware of any circumstances relating to the Target's business concerning) any litigation, arbitration, mediation, prosecution or other legal proceedings or ADR or any proceedings or hearings before any authority and that no such matters were pending or threatened or have been settled by a deferred prosecution agreement;
• had not received notice and/or was not aware of any circumstances that would give rise to an investigation or enquiry by any authority in respect of its affairs;
• had not committed any material breach of contract, tort, statutory duty or law which will cause material damage or loss to the Target; and
• had not engaged in acts of bribery and corruption.

The Exclusion

The Insurers' main defence was that they had no liability for the claim under the Policy by operation of the exclusion contained in clause 5.2.15 of the Policy (the Exclusion) which provided that:

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

"ABC Liability" was defined in the policy wording as meaning:

“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 Buyer argued that the Exclusion did not apply because the definition of "ABC Liability" contained an “obvious minor error” and should be corrected from (the Buyer's proposed amendment as in bold and underlined):

“any liability or actual or alleged non-compliance… in respect of Anti-Bribery and Anti-Corruption Laws”.

to read:

“any liability for actual or alleged non-compliance… in respect of Anti-Bribery and Anti-Corruption Laws”.

The key difference under the Buyer's reformulation of the wording was that under the proposed amended wording it would have to be established that there was an actual legal liability for breach of Anti-Bribery and Anti-Corruption Laws for the Exclusion to apply (and that a mere allegation of breach of such ABC Liability was insufficient to trigger the Exclusion).

There were also competing submissions before the Court as to the extent to which reliance could be placed on pre-contractual exchanges, including emails/WhatsApp messages between the Insurers' underwriters/underwriting agents and the insurance broker and various drafts of the Policy to resolve this question of construction.

The Buyer also relied on the fact that the relevant bribery and corruption warranty from the SPA was marked as “Covered” (without any qualification) on the cover spreadsheet which was appended to the Policy.

DECISION

The first issue considered was whether the pre-contractual materials and negotiations were admissible and/or relevant to the construction of the defined term "ABC Liability". The judge concluded that the pre-contractual emails and other materials were not relevant to the central question which was to what extent would a reasonable person, with all the relevant background information, conclude the parties had chosen to manage the risk? The starting point to this question was to look at the actual words which had been used in the policy documentation.

The judge ultimately rejected the Claimant's submission that the definition of "ABC Liability" contained an obvious drafting error which should be corrected as a matter of construction. The judge held that, as drafted, the definition of "ABC Liability" would appear to cover three species of liability:

1. "Any Liability…in respect of Anti-Bribery and Anti-Corruption Laws";
2. "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
3. "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".

The judge accordingly applied the natural meaning of the words used in the Policy and agreed with the Insurers' position. In the judgment of the Court:

• The Exclusion clause at 5.2.15 of the Policy as drafted was not inherently "absurd or obvious nonsense" and it made clear sense when read together with the Insuring Clause and other provisions of the Policy.
• Under normal English law principles for the interpretation of insurance policies and other commercial contracts, as set out in the FCA Test Case, the Policy was to be construed in accordance with the understanding of a reasonable person with all the background knowledge which would reasonably have been available to the parties when they entered into the Policy. In the judge's view, such a person would have read the word "or" as referring disjunctively to different situations each of which came within the scope of the Exclusion.

As to the Buyer's arguments that the relevant warranties had been marked as covered (on an unqualified basis) on the cover spreadsheet to the Policy, the judge found that the cover spreadsheet's purpose was to identify warranties that were covered in principle. That a general coverage exclusion (such as a general exclusion for ABC Liability) can then apply to, and qualify coverage in respect of, an individual warranty marked as "Covered" did not mean the Policy was contradictory or change the judge's conclusion that the exclusion did apply.

COMMENT

The judgment illustrates that, as always, it is challenging to establish that there is an actual mistake on the face of the wording, as opposed to arguing for a particular interpretation when more than one interpretation is plausible.

It will be rare that a policyholder can rely on pre-contractual exchanges with brokers and insurers as to the coverage the policyholder 'thought' it was purchasing in the face of express wording used in the policy documentation to the contrary – and absent meeting the test for estoppel or rectification or similar.

The outcome of this case was that the Insurers succeeded even though they expressly identified the ABC warranties as covered, while seeking to fully exclude such liability in another part of the Policy. Although the Court said that the two positions could be viewed consistently, if correct, this is unlikely to match the expectations of those buying the product. In any event, here there was a direct conflict in that an ABC warranty was marked as covered but the Policy was subject to an ABC general exclusion. In other cases where there is less of a direct match, the outcome may be different, taking into account the relevant facts and circumstances and other factors which the Court recognised are relevant in such a construction exercise, such as commercial common sense and whether the necessary causal nexus for the exclusion is established.