Representations and warranties coverage disputes are far more often resolved through informal or confidential proceedings rather than litigation. Law 360 recently published an article by Hunton insurance counsel Syed Ahmad, Patrick McDermott, and Jae Lynn Huckaba analyzing a rare representations and warranties dispute in the summary judgment stage of litigation between pH Beauty Holdings III Inc. and its representation and warranties insurers. As summarized below, the authors provide an overview of the issues in dispute, which related to the RWI retention, an exclusion related to the purchase price adjustment following closing, and pH Beauty’s bad faith claim.
On September 28, 2018, pH Beauty purchased a company known as Paris Presents, a marketer of cosmetic and bath accessories. As part of the transaction, pH Beauty purchased a buyer’s representations and warranties insurance (“RWI”) policy. The purpose of the policy was to protect against the risk that certain representations and warranties in the purchase agreement turned out to be inaccurate. The policy provided an aggregate limit of $30 million and an initial retention of $4.2 million, which dropped down to $2.8 million on the one-year anniversary of the closing date of the transaction.
pH Beauty contended it purchased Paris Presents for $575 million—a purchase price pH Beauty determined by relying on Paris Presents’ 2018 earnings. According to pH Beauty, Paris Presents provided pH Beauty with its financial records, and based on those records, pH Beauty concluded that Paris Presents was a high-performing company. pH Beauty stated it agreed to purchase the company for a multiple of 13.66 times its reported earnings. After the purchase, however, pH Beauty alleged that it learned that Paris Presents had overstated its profits, leading to an inflated purchase price. As a result, pH Beauty claimed it overpaid for Paris Presents by approximately $33 million.
Thereafter, pH Beauty filed a claim with its representations and warranties insurer, seeking reimbursement for the losses incurred due to the alleged breach of various representations and warranties. The insurers agreed that a breach had occurred and that the loss was covered, but they refused to pay what pH Beauty said was the full value of the loss. Specifically, the insurers informed pH Beauty that they would recognize a loss of $3.6 million and $373,408 in claim expenses—approximately $26.3 million less than pH Beauty’s loss calculation.
Following the insures’ failure to pay the full amount of pH Beauty’s claimed loss, pH Beauty filed a coverage action in Massachusetts state court to recover its losses. pH Beauty asserted claims for breach of contract, common law bad faith, and violations of Section 11 of Chapter 93A of Massachusetts General Laws. Two years later, the case progressed to the summary judgment stage. Each party filed a motion for summary judgment and completed the briefings for both motions on June 21, 2023. The briefings left three important issues for the Massachusetts state court to decide.
First, the parties disputed the applicable retention under the policy. pH Beauty said that the $2.8 million dropdown retention applied because more than 12 months had passed since the closing when pH Beauty made its claim against the policy. The insurers argued that the $4.2 million retention applies because Section IV.B. of the policy provides that if the insurer is able to prove that certain persons had knowledge of a “given Claim” prior to the date the retention was set to drop down, then the $4.2 million retention would continue to apply. As mentioned above, the retention was set to drop down on the one-year anniversary of the deal’s closing. The dispute over the applicable retention centers on the meaning of “Claim,” which is undefined in the policy. pH Beauty asserts that “Claim” could refer to two types of claims: (1) a claim by a third party against pH Beauty or Paris Presents or (2) a claim for coverage under the policy. The insurers focused on what they contended was the plain meaning of “Claim,” which is the stated or specified insurance claim. They also argued that the certain persons identified in the policy were made aware that the financial statements were understated prior to 12 months after closing. The dispute over the applicable retention and the meaning of “Claim” shows that insurers and policyholders should ensure that their insurance policies align with the intent of the parties. The differing interpretations of the retention-related provisions could have been resolved during negotiations or at the time of the policy’s procurement.
The second important issue before the court was whether the insurers wrongfully applied the purchase price adjustment exclusion. The exclusion bars coverage for any portion of the loss that is accounted for in the purchase price adjustment under the purchase agreement. Following the transaction, the purchase price was reduced by $5.9 million. Relying on the purchase price adjustment exclusion, the insurers claimed that $1.6 million of pH Beauty’s loss was not covered under the policy. pH Beauty disagreed, arguing that the exclusion applies only to amounts in excess of the applicable retention and that the only basis for the insurers’ position was an opinion from the insurers’ expert, rather than any documents reflecting an agreed allocation of the purchase price adjustment. To avoid similar disputes, policyholders should consider documenting what is included in a purchase price adjustment to avoid insurers trying to capitalize on any lack of clarity.
The third issue raised on summary judgment was pH Beauty’s ability to maintain a cause of action under Section 11 of Chapter 93A of the Massachusetts General Laws. The insurers argued that a cause of action under the statute was improper because the “center of gravity of the circumstances that [gave] rise to the claim” did not occur “primarily and substantially within the Commonwealth,” which was a requirement for the statute to apply. The insurers also contended that even if the claim was sufficiently connected to Massachusetts, they did not act egregiously as required for a Chapter 93A claim. They asserted that there was no evidence of any conduct that demonstrated an “established conception of unfairness” or conduct that “[was] immoral, unethical, oppressive, or unscrupulous.” pH Beauty countered that the location of the insurers’ wrongful conduct, the location where pH Beauty relied on that conduct, and the location where pH Beauty suffered harm were all primarily and substantially in Massachusetts. The company also contended that there was at least one factual issue concerning whether the insurers conduct arose to the level of commercial extortion, which it stated was a well-established concept of unfairness recognized under Massachusetts law. pH Beauty cited to one example to support the commercial extortion argument: the insurers’ conditioning payment of the undisputed covered amount on a full release of pH Beauty’s claims. The takeaway here is the importance of considering how dealing with out-of-state entities and insurers could impact a policyholder’s remedies when a breach of a representation occurs and the insurer subsequently denied coverage. Here, if the court would have found that pH Beauty could not maintain a claim under Chapter 93A, the company would have lost its ability to recover treble damages – limiting the company’s recovery to the remaining causes of actions asserted.
While the dispute progressed to the summary judgment stage, these three issues were never resolved by the Massachusetts state court. On August 23, 2023, the case was dismissed after the parties reportedly settled. But as coverage disputes under RWI policies increase and continue to progress to litigation, issues to consider for future transactions, like those described above, will arise.