RWI policies, used with frequency for more than a decade, are now ubiquitous in the private investment market. Over the last five years, the number of private investment transactions and related policies issued in connection with such transactions has soared. In fact, by 2021, underwriters were receiving more submissions than they could even process. This explosive growth in coverage is not surprising: RWI policies offer significant benefits to all parties involved in a transaction, from providing advantages to buyers looking to win deals to minimizing purchase proceeds held back in escrow for sellers.
As a result of such growth, however, claims asserted under RWI policies have increased commensurately, with those in excess of $10 million snowballing. These so-called “severe” claims have more than doubled between 2017 and 2019 alone, and they often concern seller representations regarding the accuracy of financial statements where the insured is claiming loss based, at least in part, on the alleged diminution in value of the acquired business, typically calculated through the use of an EBITDA or other purchase price multiple. In addition, tax, compliance with laws, material contracts, and customers and supplier representation and warranty breaches have provided fodder for these claims.
RWI Coverage Litigation on the Rise
The increase in RWI policies has resulted in increased coverage matters between insurers and insureds. Yet there has been little judicial guidance as to how such matters are resolved, including how courts may interpret policy and coverage issues, because insurers and insureds typically agree in RWI policies to resolve any coverage disputes through binding arbitration in order to promote efficiency in claim resolution and to provide confidentiality for the parties. That might be changing.
Three RWI coverage cases — Novolex, WPP, and pH Beauty — are currently making their way through the New York County’s Commercial Division and Boston’s Business Litigation Session courts, and they hint at a growing jurisprudence around RWI coverage litigation:
- Novolex: Commenced in New York in September 2019, this action arises out of the denial of RWI claims brought by Novolex (buyer/insured) for $267 million in damages for alleged breaches of representations and warranties by The Waddington Group (“TWG”) in a purchase agreement through which Novolex acquired TWG. According to Novolex, it had $150 million in coverage for its losses, excess of a $17 million retention. The breach concerned TWG’s purported knowledge of the intention of its third-largest customer, Costco, to significantly reduce business with TWG following the transaction. The insurers moved to dismiss the lawsuit on the basis that Novolex failed to adequately allege that the representation and warranty in question had been breached because the representation and warranty required the existence of a contract that had not been pleaded. In August 2020, the New York court denied the motion on the basis that a contract had been pleaded and, regardless, that the representation in question did not require the existence of a contract, the latter of which the court raised sua sponte. As of late 2021, the parties had exchanged more than 100,000 documents and taken in excess of twenty-five (25) depositions. Novolex also presented at least two experts in the case — an industry expert and a damages expert. Novolex is currently pending a decision on the insured’s summary judgment motion.
- WPP: Initiated two months after Novolex in November 2019, WPP (buyer/insured) also brought suit in New York against, among others, its RWI insurer to recover damages for alleged breaches of a purchase agreement through which WPP acquired a digital media company. According to WPP, it paid a price for the company that was artificially inflated by $120 million as a result of misrepresented financial projections. The insurer moved to dismiss the claims against it on several bases, including because WPP allegedly misconstrued the purchase agreement, but also because coverage was allegedly excluded under certain policy provisions. In January 2021, the New York court denied the motion, ruling that it could not find that any exclusions applied on a pre-discovery fact record. The case is now in discovery. Following extensions, fact discovery — including up to fifteen depositions per side — and expert discovery are not scheduled to be completed until December 2022, with summary judgment due in early 2023. Notably, the RWI policy at issue provided WPP with the option to bring claims in either confidential arbitration or in New York court, and WPP elected to proceed in New York state court rather than arbitration.
- pH Beauty: The most nascent of the three cases, this action was filed by pH Beauty (buyer/insured) in July 2021 in connection with its acquisition of a company called Paris Presents. pH Beauty alleges that the sellers of Paris Presents failed to account for millions of dollars in promotional expenses incurred to generate its earnings, inflating the purchase price by at least $34.2 million. After investigation, the insurer ultimately recognized a $3.65 million loss and $373,408 of claim expenses, net of the retention. pH Beauty brought the action in an effort to recover from the insurer the balance of its $26.35 million in alleged losses and also seeks treble damages under Massachusetts Gen. Law c. 93A. The case is now in fact discovery, which will include up to 30 interrogatories and 75 requests for production of documents per side. According to the court’s scheduling order, discovery will close in late 2022, with summary judgment in early 2023.
Although the outcomes of these cases remain open, there are already some important lessons to be learned, both in terms of the types of disputes that are resulting in active litigation and how the courts are treating them. First, all three cases involve claims in excess of $10 million, suggesting that insureds are willing to engage in litigation on claims where damages are substantial and sufficient to justify the cost. Second, the cases also concern representations and warranties frequently subject to RWI claims — concerning the accuracy of financial statements and material customers — suggesting that there will continue to be litigation of disputes arising out of these alleged costly breaches. And, third, none of the pending cases achieved early resolution through motion practice, resulting in significant discovery phases. That means, absent settlement, long and costly discovery, including extensive document production, depositions, non-party discovery, and expert discovery to the extent rarely found in arbitration, should be anticipated. Furthermore, even after discovery and summary judgment briefing is complete, Novolex cautions that these disputes are unpredictable as they involve the interpretation of “dense corporate agreements with ambiguous, wordy provisions ripe for creating disputes between contracting parties and insurers” that can lead to uncertain and unanticipated outcomes in litigation.
More to Come?
As these litigations continue to work their way through the New York and Boston commercial courts, there will be more opportunities for the court to issue public opinions interpreting disputes on RWI claims. As that occurs, we can expect to get first impression, public guidance on a variety of relevant issues, including the scope of permissible discovery, how exclusions typical to these policies will be interpreted and applied by courts, and accepted damages calculation methodologies — all of which could provide clarity to insurers and insureds facing similar claims. Given the volume of RWI policies placed in the market, it is also possible that repeat players will emerge in disputes informing policy placement, both on the insurer and insured sides.
Moreover, although arbitration has the benefits of being confidential and efficient, recent trends reflect that the use of arbitration agreements in private investment transactions is declining. As more transaction agreements feature agreements to litigate in court, buyers may likewise attempt with increased frequency to litigate RWI claims in court, whether through an express venue provision in the RWI policy or simply going silent in the policy as to venue. But, whether such disputes ultimately land in arbitration or the courts, Novolex, WPP, and pH Beauty are, and will remain, highly instructive with respect to the resolution of RWI claim disputes in any forum.
Please note that the issues and cases described herein are provided in summary fashion. If you would like additional information about any of the issues discussed in this client alert, please contact Joseph P. Rockers, Christine V. Sama, or Dylan Schweers, or the Goodwin lawyer with whom you typically consult.
2021 Market Report: Representation & Warranties | Gallagher USA (ajg.com).
Novolex Holdings, LLC v. Illinois Union Ins. Co., Index No. 6555514/2019 (NY Cnty. Sup. Ct.).
WPP Group USA, Inc. v. RB/TDM Investors, LLC, Index No. 656825/2019 (NY Cnty. Sup. Ct.).
pH Beauty Holdings III, Inc. v. Certain Underwriters at Lloyd’s, London, Case No. 21-1586-BLS (Mass. Sup. Ct.).
Court Refuses to Dismiss Claims in RWI Lawsuit (americanbar.org).
Joseph P. RockersPartner
Christine V. SamaPartner