"To indemnify or not to indemnify, that is the question….. Whether 'tis nobler in the mind to suffer the slings and arrows of a contractual warranty claim or to take arms against a sea of product mis-selling and, by opposing, recover under the indemnity....."     

There is a hint of Shakespearean drama in the English Court of Appeal decision of Andrew Wood v Sureterm/Capita Insurance1. (And, by the way, the quote above is not from the judgment....! I made it up). It's rare to read a case which so clearly demonstrates the conflict which can arise from muddled drafting in a business transaction.

What happened?  Discovering the mis-selling

Andrew Wood was managing director and majority shareholder in an insurance broking business called Sureterm, offering policies in the classic car market. In 2010 he and his fellow shareholders sold the business for around £7.7m (plus deferred consideration) to Capita.

Shortly after the sale, Capita became aware of some serious mis-selling of insurance products which had taken place in the Sureterm business prior to the sale. Capita reported its discovery to industry regulator the Financial Services Authority. The FSA required Capita to compensate thousands of Sureterm customers affected by the wrongdoing. Capita incurred costs of around £2.4m in doing so.

What redress did Capita have against Andrew Wood?

Under the share sale agreement, Wood warranted that the conduct of the Sureterm business prior to its sale complied with all financial services regulations. Plainly, it had not. But Wood also indemnified Capita against losses arising from mis-selling which had taken place before the sale. Unlike warranty claims, that indemnity was not financially capped.

On paper, you would have expected Capita to have a clear-cut right to recover under the indemnity. But the difficulty Capita faced was in the drafting of the indemnity: it was a convoluted, hard-to-read 11-line clause, with a number of concepts strung end-to-end, and with a lack of clarity about the carve-outs, qualifying statements, and even the purpose of the commas (the Court of Appeal commented that commas were used "erratically")!

Hardly surprisingly, the indemnity could be interpreted in different ways. Wood argued that Capita could only recover under the indemnity if it was third parties (eg customers) which had notified the FSA of the mis-selling. Because Capita itself had reported the wrongdoing to the FSA, that meant that Wood was "off the hook". By contrast, Capita argued that it was covered by the indemnity, regardless of who happened to have notified the FSA.

Court of Appeal decision

The High Court agreed with Capita's reading of the indemnity, concluding that it was indemnified. However, the Court of Appeal (comprising three very experienced and senior commercial judges) unanimously reversed that decision. The Court held that because Capita itself had reported the mis-selling, it indeed could not claim for any of the £2.4m.

The Court devotes several pages of its decision to principles of contract interpretation, going through the clause in painstaking, and sometimes pedantic, detail.

The Court also addresses wider commercial considerations, seeking to explain why Wood might have agreed to indemnify Capita only against costs relating to mis-selling later reported by third parties, but not costs arising from self-reporting by Capita.

The business outcome for Capita was devastating: Capita had bought a business which turned out to have been mired in serious mis-selling, but could not claim under the indemnity, merely because it had reported the mis-selling itself (a proper step to take, you might have thought), rather than waiting for customers to contact the FSA! The Court of Appeal describes the deal, as interpreted by itself, as a "poor one" for Capita. That's an understatement.

Some take-away lessons

An obvious take-away lesson is to draft clauses clearly. But that's a cliché, and so obvious that it doesn't need saying. A more important take-away lesson is to 'role play' indemnities - ie to take the indemnity mechanism and ask:

  • how would this work in practice?
  • What factual event triggers a claim?
  • What is intended to happen then?

These role plays are like a simulation exercise, which are intended to bring business-critical language to life. I'm certain that such an exercise could have exposed the indemnity muddle, if Capita had managed to undertake it before signature. I realise there's often precious little time in the heat of negotiation to do so, but the time investment is surely worth it.

This case should prompt a review of how indemnities are drafted and negotiated, across industry sectors and practice groups. Businesses must ensure that the events triggering indemnity rights are aligned with real-world business risk, and that following signature they undertake the practical steps needed to maintain, rather than forego, indemnity protection.