W&I insurance: Growing pains or coming of age?

Applicable law and quantum of damages

The insuring clause usually provides that the buyer can recover under the policy the damages it would have been able to recover under the SPA or management warranty deed (MWD) if the key restrictions (defined usually as "limitation provisions") had been disapplied. Therefore, how damages are usually assessed under the applicable laws of the SPA or MWD is key. 

In England, the default position will usually be a calculation comparing the warranty true/warranty false basis, assuming a hypothetical willing buyer and seller operating at arm's length (i.e. the diminution in value or DIV). This often requires expert evidence, and in undertaking the calculation, a breach can impact a number of variables in a valuation. For example, if the appropriate method of valuation is an estimate of EBITDA to which a multiple is applied, breaches of warranties can affect both of those inputs – compounding the effect on quantum.

A similar approach can be seen in Australia and the US, but in some European countries, such as Spain, the default is the indemnity basis of damages. Ultimately, which methodology results in a more substantial claim depends on the facts and how those impact the objective valuation (DIV) or lead to a clearly indemnifiable loss (indemnity basis). It is, of course, possible to prescribe the indemnity basis where the default is DIV, and some clauses give the insured the option. 

Disclosure always matters

Insurers will not generally be looking to cover known matters. They may achieve this through exclusions for matters known to the insured, and/or what is disclosed (as defined) both under the SPA/MWD and policy. What is disclosed may well include information in the data room and diligence reports. The policy wording may supersede, improve or worsen the test under the SPA and close attention should be paid to this. 

Where available, a disclosure "scrape" can be money well spent. This is when the insurers agree that the data room and/or due diligence reports will be deemed not disclosed for the purposes of the W&I Policy and results in a position more aligned to that under US Reps and Warranties policies. This can be useful in preventing insurers from asserting that passing or oblique references to facts in the data room or diligence reports are "disclosed". However, it is important to make sure that the effect is not undermined by representations in the No Claims Declaration as to what the deal team have read or considered.