W&I insurance in the M&A market - is there potential for contribution claims against sellers?

We consider why buy-side insureds are starting to request the exclusion of insurers’ subrogation rights against the buyer’s professional advisors. Are concerns that contribution claims might be made against the seller well founded?

In brief

In a softening W&I market, insurers have been conceding increasing ground to insureds in W&I policies. In the context of attempts by W&I insureds to exclude insurers’ rights to subrogate claims against the Buyer’s professional advisers, we ask whether, if found liable, the Buyers’ advisers can then claim a contribution from the Seller.

In short, where the underlying SPA contains a nil recourse provision, we do not believe that a professional adviser found liable for negligence in relation to a breach of warranty could then seek a contribution from the Seller, thus defeating the purpose of achieving a ‘clean exit’ for the Seller in W&I-backed M&A.

The changing landscape of W&I

Ten years ago, there was a more limited pool of insurers underwriting W&I insurance in the UK market. A flood of new entrants into the W&I market more recently has softened the market, giving insureds much greater negotiating power over policy terms. The overriding philosophy now appears to be geared towards ensuring a “clean exit” for the Seller. As a result, we have seen generous concessions by insurers, including previously large retentions in W&I policies often now reduced to nil.

Many SPAs also now contain nil recourse provisions (capping the Seller’s liability for breach of warranty, designed to allow a “clean exit” for the Seller).

In addition, whereas warranties in an SPA are very often qualified, and given only to the best of the Seller’s information and belief, we have seen an increase in so called “knowledge scraping” in the associated W&I policy, whereby this qualification is “scraped” from the policy wording and the W&I cover is given on an unqualified basis.

The combined effect of these developments is that any subsequent breach of warranty claims will almost wholly fall to the W&I insurance policy. The Buyer (or the Buyer’s insurer), with nil recourse against the Seller, may then look to claim against relevant third parties, such as their professional advisers on the transaction.

There is then a risk that the advisers will bring a contribution claim against the Seller, which could potentially undermine the Seller’s “clean exit” from the transaction. This, in turn, appears to be the basis for requests for further concessions by W&I insurers, in the form of the express exclusion of insurers’ rights to subrogate against the Insureds’ (the Buyer’s) advisers. (It is standard for the insurers to have waived their right to bring a subrogated claim against the Seller save for cases involving fraud.) If insurers were to agree to this, it would deprive them of a potentially important means of clawing back all or some of their loss from professional advisers who had conducted the due diligence negligently.

Contribution claims

The Contribution Act 1978 enables one defendant to claim contribution for damages from another defendant who is liable to the claimant in respect of the “same damage”. If the Buyer (or the W&I insurer subrogated to the rights of the Buyer) brings a claim against the professional adviser, there may well then be attempts to seek a contribution from the Seller itself.

Where the adviser is liable to the Buyer for professional negligence, whether the Seller is liable to the Buyer in respect of the “same damage” as the adviser depends on the wording of the purchase agreement.

The issue of whether a Seller and adviser had the same liability to the claimant was discussed in the Eastgate v Lindsey Morden case, where the seller and the adviser “were liable for the same damage viz the loss arising from the fact that Eastgate have bought a company worth less than Eastgate reasonably expected it to be worth”.

Key to the analysis, however, is consideration of the relevant SPA provisions. Both the original defendant and the party from whom a contribution is sought must be liable to the claimant in respect of the same damage, or some of it. If there is no nil recourse provision in the purchase agreement, the adviser could in principle make a claim for contribution against the Seller. If the SPA does contain a nil recourse provision, however, the Seller has no liability to the Buyer, and the test for liability under the Contribution Act 1978 fails, so that the adviser would not be able to seek contribution from the Seller.

Take away

If concerns about potential contribution claims are the basis for recent requests by insureds to exclude subrogation rights against professional advisers, we believe that these concerns are unfounded in situations where the relevant SPA contains nil recourse provisions. In those cases, there is no need to limit the insurer’s rights of subrogation against the Buyer’s advisers in the policy, thus depriving the insurer of a means of clawing back its loss. If the Seller’s liability is limited to the Buyer, it is also limited to anyone against whom the Buyer might make a claim.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.