A rare lawsuit concerning coverage under a reps & warranties policy presents two issues of interest to M&A lawyers:

  1. If the insured under a reps & warranties insurance policy fails to obtain the insurer’s consent to a settlement, coverage for that settlement is forfeited, even if the settlement was “panicked” and on a short timeframe.
  2. Sell-side policies do not cover allegations of seller fraud. This is why buy-side policies are preferred – they cover the buyer’s losses resulting from seller fraud.

The buyer of a whey-manufacturing company (Granite Creek Partners) alleged that the seller fraudulently failed to disclose that it “secretly” added urea to its whey product, artificially inflating the protein content of the product. After entering into a hasty settlement with the buyer, the seller sought coverage under the reps & warranties policy, arguing that claims of fraud and breach of general reps were covered by the policy.

This is a novel issue, unique to reps & warranties insurance, and also unique to sell-side policies. The policyholders might have had better success had they not committed the age-old error of treating insurance as an afterthought.

The seller could have prevented a world of woe by doing the following tasks, all of which were within its control:

  • Negotiate a prejudice requirement in the notice clause in the policy – this is standard in reps & warranties policies
  • Provide timely notice of the claim
  • Position the claim to maximize coverage
  • Obtain the insurer’s consent to settlement

Instead, the seller provided notice three weeks after finding out about the claim. Three days later it notified the insurer of the near-final settlement — at 7:30 p.m. on Christmas eve. The seller was agreeing to pay millions in excess of both the policy retention and the escrow. As the court noted, this “panicked” approach to presenting the claim prejudiced the insurer and was a basis for denying coverage. It also likely prejudiced the policyholder, who in haste presented the claim to the insurer in the worst possible light. One also wonders whether in all that haste, the seller’s D&O insurance tail coverage was considered as another source of coverage. The case is on appeal, and we will follow it in this blog.