- Whether an insured was entitled to indemnity under a buyers warranty & indemnity policy following the purchase of shares in a company which had overstated its income and misrepresented its liabilities to a major supplier, and where an arbitrator had already found in favour of the insured against the seller of the share
The plaintiff, UDP Holdings Pty Ltd (UDP) held a buyer warranty and indemnity insurance policy issued by the defendant underwriters. The policy provided cover in respect of a share sale agreement dated 11 December 2013, whereby UDP purchased all shares in 5 Star Foods Pty Ltd from Esposito Holdings Pty Ltd (sale agreement). The purchase price was $70 million and the defendants’ liability under the policy was capped at $25 million.
5 Star Foods (Seller) traded in milk products. The company was founded by Mr Esposito and in 2012 he decided to sell it and its subsidiary companies (the Group). Its most important customer was LD&D Australia Pty Ltd, a member of the Lion Nathan Group. 5 Star Foods supplied milk and other dairy products on a cost plus margin basis to Lion under a contract dated 25 August 2008. On about 17 February 2014, after the sale agreement was completed, Lion advised the Group that it had been overcharged by approximately $3 million annually from 2012 to 2014. The Group’s auditors investigated the complaint and found it had overcharged Lion by $9.3 million between July 2011 and January 2014. On 28 March 2014 the Group reached settlement with Lion about the overcharging.
UDP’s evidence was that had it been aware of the Lion overcharging, the sale agreement would not have gone ahead. The Group’s financial position was much worse than shown in the financial accounts available prior to acquisition. It was not in dispute that Esposito had breached clause 15.1 of the sale agreement on 2 occasions. Receivers and managers later sold the Group’s business for $22.5 million, which was $47.5 million less than the purchase price under the sale agreement.
In October 2014, Esposito referred a claim against UDP for the unpaid balance of the purchase price of about $9 million to arbitration. UDP counter-claimed from Esposito $47.5 million for breach of warranties and loss arising from the Lion overcharging.
On 2 March 2015 UDP notified underwriters of circumstances which might give rise to a claim under the policy and on 14 May 2015 it made a claim on the policy supported by an expert accounting report. In February 2016 UDP commenced proceedings against underwriters claiming loss exceeding the policy limit of $25 million. On the underwriters’ application, a temporary stay of the proceedings was granted until the completion of the arbitration.
In September/October 2018 the arbitrator determined that the Group overcharged Lion by $12,440,150 and that the Group had suffered loss and damage of $54,144,847. An order was made giving effect to the award but no amount had been recovered at the time of the trial.
The Decision at Trial
There were numerous issues for the Court to determine. The first was whether the underwriters were estopped from denying the arbitral award in UDP’s favour. All of UDPs submissions on this argument were rejected with the Court holding that it would be unjust if the underwriters were denied the right to contest UDP’s claim because of an arbitral award made against the Seller on different issues to those arising under the policy, and in proceedings in which they had no right of appearance.
The next issue was how to quantify the loss suffered as a result of the warranty breaches. The different experts called by the parties adopted different methodologies to quantify the loss. The Court held that the amount of the loss for breach of contract should be determined in accordance with the principles in HTW Valuers (Central Qld) Pty Ltd v Astonland Pty Ltd (2004) 217 CLR 640 (HTW)- that is by determining the difference between the price paid and the fair or real value of the assets acquired at the date of purchase. After considering the differing methods proposed by the experts, the Court assessed UDP’s loss at $30.85M – significantly higher than the $25M policy limit.
The Court then noted that although UDP had commenced action to recover funds from the Seller, the process was far from complete and likely to take substantially longer having regard to the potential need for litigation and possible difficulties with market conditions. The Court also noted there would be considerable costs associated with the tracing and realisation of assets and the recovery of sums due to UDP under the award.
This led to the issue of issue of whether the underwriters were required to make payment to UDP while there remained a possibility that some amount would be recovered and reimbursed to them. The underwriters alleged that in those circumstances, UDP had not yet suffered a ‘Loss’ for the purposes of the policy. Alternatively they contended that the amount of the Loss could not be ascertained. As a result, they argued that they were not liable to indemnify UDP under the policy. This argument was held to be inconsistent with the proper construction of the policy. The Court determined that the underwriters’ obligation to indemnify was not dependent on the prior collection of all recovered amounts. The conditions of the policy were clear and unambiguous and did not support the underwriters’ submissions. An interpretation of the policy to the effect that an insured could not make a claim, or that the underwriters were relieved of their duties to decide a claim until all Recovered Amounts had been received from third parties would leave an insured financially exposed, and largely at the whim of the underwriters. It would be an uncertain, uncommercial and unworkable situation. The underwriters’ position as to Recovered Amounts was held to be well protected by cl 9.5 of the policy which safeguarded the underwriters from the possibility of double recovery by UDP, and required UDP to account for any surplus.
UDP argued that it was entitled to recover its costs of the arbitral proceedings ($2.23M) because the underwriters breached their duty of good faith by failing to indemnify it for the costs of the arbitration. It submitted that the underwriters caused UDP to incur the costs of the arbitration by obtaining a stay of this proceeding until the arbitration was completed. The Court was not satisfied the underwriters had acted in breach of their duty of utmost good faith. There was no dishonesty or impropriety by the underwriters. There was no absence of commercial standards of decency and fairness, or failure to have due regard to the interests of the insured. There was no lack of competence or failure to respond. The underwriters were not parties to the arbitration and were not responsible for the delays in the conduct of the arbitration caused by the unexpected difficulties that transpired. This claim failed.
The Court then had to consider whether UDP was entitled to interest under s57 Insurance Contracts Act 1984 (Cth) (IC Act), and found that it was so entitled. Given that the underwriters had advance notification of the claim on 2 March 2015, and the benefit of comprehensive reports including a detailed loss assessment by 14 May 2015, along with numerous supporting documents, the court held it was unreasonable to withhold payment on and from 14 September 2015 –which was four months after the policy claim was made, two and a half months after UDP had responded to multiple requests for documents, and over six months after the notification of circumstances.
The Court determined that UDP was entitled to judgment in the sum of $25 million, being the limit of liability under the policy, plus interest under s57 of the IC Act commencing on and from 14 September 2015.
Implications for you
This decision serves as a warning to insurers not to delay indemnification and payment on the basis of related proceedings for recovery of losses. Doing so gives rise to exposure to a significant interest award. Insurers can however take comfort from the Court’s determination that the arbitral award did not create an estoppel in favour of the insured, and did not give rise to an entitlement to significant legal costs for those proceedings. In addition, the decision re-affirms existing principles of contractual interpretation, creating greater certainty for parties in managing litigation.