As mergers and acquisitions worldwide exceed $3 trillion annually, the market for representations and warranties insurance has accelerated. The insurance is designed to protect against the breach of a representation or warranty in an M&A transaction, and is seen as a way to facilitate rapid closing of transactions. The growth in the market for this insurance has been helped by insurance company promises of efficient underwriting and rapid response to claims, and many insurance companies have entered the market in recent years.
Claims frequency also has increased, with claims currently being brought under about 20 percent of policies sold. Unsurprisingly, the largest deals have the highest claims frequency and the largest claims pay-outs. Among the largest causes of claims are compliance with laws, financial statements, tax-related issues and intellectual property disputes.
There are almost no reported cases involving insurance coverage disputes under representations and warranties policies. Some of this may be due to coverage issues being more readily resolved through negotiation than, for example, coverage issues in environmental claims.
The more likely reason, however, is that most representations and warranties policies have arbitration clauses that preclude litigation. If a policy does indeed include a mandatory arbitration clause, representations and warranties policyholders should take into account key differences between arbitration and litigation procedures and tailor their strategy accordingly, should a claims dispute occur.
Arbitration is considered to promote more efficient and cost-effective resolution of disputes than judicial litigation. In addition to offering speed and cost savings, arbitration is final. Courts read arbitration agreements broadly, even in standard-form, non-negotiated contracts. Insurance companies choose arbitration over litigation in order to avoid various rules that courts have developed that favor policyholders, such as construing ambiguities in favor of insurance coverage.
Working With Minimal Discovery
Perhaps the biggest difference between judicial litigation and arbitration is the scope of pretrial discovery. Judicial discovery is exceedingly broad, with the scope of “relevant” discovery broadened to include matters that may lead to relevant evidence. The Federal Rules of Evidence have limitations on the number of depositions and interrogatories, but those limitations are often honored in the breach.
Discovery in arbitration, in contrast, is designed to be minimal and informal. The important event usually is the initial meeting between the arbitrator and the parties, where discovery rules are set. The arbitrator has broad discretion over discovery. The arbitrator will follow any agreements of the parties, but an insurance company is unlikely to agree to broad discovery.
Document requests in arbitration must be limited to directly relevant documents, and restricted in time and subject matter. Requests for “all” documents are a red flag. Depositions generally are disfavored in arbitration. Under the American Arbitration Association’s (AAA) Commercial Arbitration rules, depositions are allowed “in exceptional cases” at the arbitrator’s discretion and “upon good cause shown.” Judicial Arbitration and Mediation Services, Inc. (JAMS) allows one deposition of an opposing party or an individual under the control of an opposing party, unless the arbitrator allows for more. Discovery disputes are resolved quickly, with minimal briefing, with a preference for consensual resolution.
Targeting Underwriting, Claims, and Regulatory Submissions
It is absolutely necessary in an arbitration to have a discovery plan with a targeted approach. Document requests must be focused on getting information necessary to a claim or defense. For the policyholder, there should be two, and possibly three targets for document requests. The first target is the underwriting of the policy. There likely will be questions about whether a claim fits within the coverage provisions or exclusions of the policy, and the underwriter’s understanding of the transaction and the coverage being provided may be critical. The policies provide coverage for ‘misstatements’ in representations and warranties. Discovery of the underwriter may help determine whether a representation was a covered misstatement, or fits within a policy exclusion. The underwriter’s knowledge of the transaction at the time of policy issuance may be dispositive of these issues.
The second target should be the claims handling process. This may reveal the insurance company’s understanding of the merits of the claim after it conducted its investigation. It also may be relevant in some jurisdictions whether the insurance company was prejudiced if notice was late, if the jurisdiction requires the insurance company to prove prejudice to avoid coverage. Finally, if you have reason to believe a similarly-situated policyholder was treated differently by the insurance company to your detriment, the arbitrator may, over the strong objection of the insurance company, allow you to obtain documents on the issue.
The relevance of the third category of document production depends on whether standard policy language, typically an exclusion, is at issue. If the exclusion’s language was approved by a state insurance regulator, the policyholder may be allowed to obtain documents concerning representations to the regulator by the insurance company when the exclusion was approved that explain the scope of the exclusion. For example, in the New Jersey Supreme Court’s decision in Morton International, Inc. v. General Acc. Ins. Co. of America, 134 N.J.1, 629 A.2d 831 (1993), the court relied on the representations made by the insurance industry to regulators when the “sudden and accidental” pollution exclusion was promulgated to hold that the exclusion barred coverage only for the intentional discharge of pollution, rejecting the insurance companies’ argument that the exclusion barred all gradual pollution. Representations and warranties policies often have an exclusion for “pollutants.” Even though it is a defined term, there may be a question of whether a common commercial product, even if harmful in the environment, is a “pollutant.” Any statements by the insurance company to the state regulator about the exclusion’s meaning when the regulator approved it may be helpful.
What depositions are necessary will depend largely on the document production, although relevant oral communications may be pertinent. Some documents may be so helpful that further explanation is unnecessary, although a party always wants to know what their adversary will say. Depositions must be targeted and to the point.
Arbitration is less expensive than traditional litigation and leads to far faster resolution of a dispute, two real benefits. Discovery is far more limited in arbitration. Depending on the parties’ status, that may be a good thing. In a dispute concerning representations and warranties insurance, the policyholder also may not need much discovery. In an arbitration, a party must learn to make do with less, and focus only on what is truly necessary.
David L. Elkind is an attorney in the Washington D.C. office of Anderson Kill. He has recovered more than $1.3 billion for corporate policyholders in a wide range of insurance coverage disputes. Contact him at [email protected]
Published September 13, 2018.