In the past 12 months there has been a reported increase in M&A activity globally and a corresponding uptake of Warranty & Indemnity (W&I) insurance products sold to an expanding market. This heightened activity increases the risk of W&I claims being made and notified to insurers. In this article we take a look at the steps required to be taken by insurers in resolving W&I insurance claims in the context of the present Australian and global landscapes.

Warranty and indemnity insurance – what is it?

In the 1990s, insurers identified that during the negotiation of a sale and purchase agreement there will often be disparity between parties over the warranties a seller is prepared to give and those a buyer is prepared to accept. W&I insurance (or Representations and Warranties Insurance, as it is known in the US) allows the parties to bridge that gap, providing some certainty to the warranties or indemnities provided by transferring the financial risk of any breach to the insurer.

W&I insurance can be purchased by either a buyer or seller, and its wording will be tailored to the specific transaction. The type of transactions in which W&I insurance is being taken out is becoming increasingly varied. Policies are ordinarily designed to sit back to back with the warranties or indemnities provided under the underlying transaction agreement (such as an SPA) although common exclusions will include losses relating to:

  • Projections and forward-looking statements;
  • Known claims or circumstances which could give rise to a claim;
  • Fraud or dishonesty by the insured;
  • Consequential losses;
  • Environmental pollution
  • Fines and penalties;
  • Post completion adjustments.

Buy-side W&I policies are first-party policies that cover a buyer's loss arising from a breach of warranty or indemnity. A buyer may be particularly interested in purchasing a buy-side W&I policy in circumstances where the seller is unable or unwilling to provide the buyer with satisfactory financial protection, transferring the financial risks of any breach of warranty or indemnity to the insurer.

Sell-side W&I policies are third-party policies that cover a seller for losses arising from a buyer's claim against them for breach of warranty or based on an indemnity provided in the sale contract including costs of defending a claim. This type of policy is often used to facilitate a clean exit from the business by either reducing or eliminating the requirement for the seller to retain funds in escrow and releasing the sale proceeds for immediate use by the seller.

W&I Claims – assessing the claim

In a competitive M&A market, the challenge for insurers is to balance the insured's interests with their own interests, while maintaining a product that will respond to claims promptly and provide parties with the level of comfort and certainty that the insurance is designed to provide.

In investigating a claim it is important for insurers to take into account any relevant local laws and practices of both the governing law of the policy and/or the jurisdiction in which a claim is or may be made. For example, this may include the local laws of insurance generally, laws relating to the relevant breach of warranty or indemnity and recovery of damages generally including any applicable local taxation or accounting standards or laws and environmental laws.

A breach of indemnity claim will arise where there has been a breach of a promise to repay another party to the contract upon a certain type of liability arising. A common example relates to tax indemnities provided under an SPA.

For a breach of warranty claim, insurers need to make an early assessment of the following:

  1. Whether there has been a breach of warranty which triggers indemnity under the policy; and
  2. If yes to 1 - what are the likely damages?

For the remainder of this article we consider the steps which may need to be carried out in determining a breach of warranty claim, which can be a complex process.

Is there a breach of warranty?

A warranty is a contractual term. Examples of breaches of warranty under SPAs include breaches of warranties relating to the truth, fairness and accuracy of the financial statements and company records, and their compliance with local relevant accounting standards.

One of the first steps in investigating the underlying facts of the breach of warranty will usually involve a thorough examination of the documents and information disclosed in the transaction dataroom or otherwise during the due diligence process. Expert evidence may also be required at this stage to determine whether there has been any breach of the relevant warranty. The next step is to assess what, if any, is the measure of damages arising from a breach.

Assessing damages

One of the most challenging tasks for insurers can be the calculation of any damages. As a starting principle, the general rule in Australia for damages in contract is to put the innocent party in the position it would have been in but for any breach: see Golden Strait Corporation v Nippon Kubisha Kaisha (The Golden Victory) [2007] 2 AC 353; Wenham v Ella (1972) 127 CLR 454; Monarch Steamship Co Ltd v Karlshamns Oljefabriker (A/B) (1949) AC 196; Campbell v Backoffice Investments Pty Ltd [2009] HCA 25. Under a share sale agreement, the measure of loss is calculated as the difference between the value of the share(s) as warranted and the true value of the share(s): see Lion Nathan Ltd v C-C Bottler Ltd [1996] 1 WLR 1438.

Determining the measure of any loss involves a valuation exercise to establish the sale amount a willing buyer and seller would have agreed to in an arms-length transaction for the sale/purchase of the asset or liability. The starting point will generally be the amount actually paid. However, the assessment of these values is rarely simple and there is generally no standard or agreed methodology which applies in valuing shares: see Sycamore Bidco Ltd v Breslin [2012] EWHC 3443 (Ch).The engagement of experts, including accountants and/or valuation experts, may be necessary in order to value the claim. In particular where the claimant seeks damages based on the application of a purchase price multiple, this can lead to very substantial claims.

Late last year, the UK Queens Bench delivered the judgment of Hut Group Limited v Nobahar-Cookson [2014] EWHC 3842 (QB) which affirmed a number of propositions regarding the calculation of damages for a breach of warranty under share sale agreements as follows:

  1. The proper measure of damages is a comparison between the value of shares as warranted and their actual value, that is, "warranty true" vs "warranty false".
  2. The normal rule is to make that comparison as at the date of the breach, which is the date of the contract and only taking into account events up to that date.
  3. However, where the value of the shares depends on the outcome of a future contingency, the known outcome of that contingency may be taken into account where necessary to give effect to the overriding compensatory principle.
  4. The prima facie rule is that damages are to be assessed as at the date of breach without hindsight. Any departure from the rule must be justified.  Hindsight cannot be used to confound the allocation of risk under the bargain.  It is inappropriate for the court to deprive a buyer of the benefit of a contingency under the contract.
  5. In a share sale agreement involving a once and for all exchange of consideration, the party which receives the business or shareholding in the business assumes both the risks and the rewards of its subsequent performance or failure to perform

In relation to 4 and 5 above, the Court considered that where there has been a breach of warranty, the mere fact that a buyer later recovers the value of the shares purchased because the business does well, does not necessarily have an impact on the quantum assessed as at the date of the breach. A buyer can still be entitled to the benefit of any upside, having taken the risk of any downside in entering the agreement.

Hut Group has not yet been followed or considered by Australian courts.  However, in Bresam Investments Pty Ltd v Shmee Pty Ltd [2009] VSCA 315, the Victorian Court of Appeal considered it open for the Court to have regard to a company's post-sale performance in determining damages, at least in aid of determining whether loss had actually been suffered and in calculating future maintainable earnings. The Court did not however make any comments on the propriety of having regard to subsequent events or how damages should be assessed according to the particular circumstances.


As M&A activity in Australian and overseas markets is tipped to increase, an expected consequence of this will be an increased uptake in W&I insurance products. Resolving W&I claims can be a complex process and in this market, it is important for W&I insurers to respond to claims promptly by carrying out early investigations and assessments of claims for breaches of warranty or indemnity and the measure of any damages.This can be done by early engagement of lawyers and experts, including those with knowledge of any relevant local laws or practices which are likely to have an impact on determination and conduct of the claim.