Reflection of surrounding buildings on RPC's building.

Acquisitions: clause in SPA construed as a covenant to pay, not an indemnity

Published on 02 June 2020

When will a clause be considered a covenant to pay as opposed to an indemnity?

The key takeaway 

In determining whether a payment obligation clause is expressed as a covenant to pay or an indemnity, the court will look at the proper construction and interpretation of the language of the clause against the factual matrix and the rest of the terms of the agreement. 

The background 

Pursuant to a share purchase agreement (SPA), AXA (indirectly) acquired from Genworth the entire share capital of two insurance businesses (together F) which were in the business of underwriting payment protection insurance (PPI) for store cards. The PPI was marketed and sold to customers on AXA’s behalf by Santander under an agency agreement. 

Unfortunately, there were extensive PPI mis-selling complaints by customers against F. Santander accepted liability for certain claims but there was a dispute as to whether it was liable for mis-selling complaints underwritten by F and arising prior to 14 January 2005. In negotiating the SPA, AXA and Genworth anticipated that F and Santander would enter into an agreement under which Santander would accept liability for all complaints, causing Genworth’s liability to cease. On this basis, clause 10.8 of the SPA provided as follows:

“The Sellers hereby covenant to the Purchaser and each Target Group Company that they will pay to the Purchaser or such Target Group Company on demand an amount equal to: 

a) ninety percent (90%) of all Relevant Distributor Mis-selling Losses; and 

b) ninety percent (90%) of the amount of all costs, claims, damages, expenses or any other losses incurred by the Purchaser or a Target Group Company after Completion resulting from the

Relevant Distributor Dispute or settlement thereof including any such losses incurred pursuant to any Action which arises from such Relevant Distributor Dispute, but excluding, after the First Termination Date, the amount of all such losses resulting from a dispute described in clause (a) of the definition of “Relevant Distributor Dispute”…

… Within thirty (30) Business Days of each of the First Termination Date and the Second Termination Date the Purchaser will issue a final demand in respect of all accrued and unpaid obligations of the Sellers under clause 10. 8(a) or, as applicable, (b) and upon payment of such demand the Sellers shall be released from their obligations under this clause 10. 8…”

However, after execution of the SPA, Santander refused to enter into a settlement agreement and pre-2005 complaints were directed solely at F, which was left facing significant liabilities. 

AXA therefore issued a demand payment of approximately £28.5 million under clause 10.8 of the SPA and, when payment was not made, issued proceedings to recover the amount demanded.

Genworth argued that the payment obligation contained in clause 10.8 was an indemnity, not a performance bond, and therefore Genworth was not under an obligation to pay until F had asserted all defences reasonably available to it in respect of the liabilities. AXA countered that clause 10.8 was a bespoke provision pursuant to which Genworth had covenanted to pay identified losses on demand and there was no requirement for F to advance all reasonably available defences.

The decision 

The Court accepted that its task was to construe the contractual language of the clause against the factual matrix to the SPA and the other terms of the SPA as a whole, using well established contractual construction principles.

The Court found that Clause 10.8 was a bespoke provision agreed between the parties that need not be classified either as an indemnity or a performance bond. The language used was a promise or “covenant” to pay which was triggered by the demand and not an agreement to indemnify. Had the parties intended the converse, they would have stated so. 

As such, the Court found that on the ordinary and natural meaning of the language of clause 10.8, Genworth was obliged to pay the demand and it was neither an express or implied requirement of the SPA that AXA prove that all reasonably available defences had been advanced.

Why is this important? 

It is common for agreements governing significant transactions to include bespoke provisions that set out how a particular risk or liability and any associated payment obligations will be dealt with post completion. The usual principles of contractual construction are more important than categorisation of terms.

Any practical tips? 

When seeking to allocate risk/liability between the parties (eg through covenants to pay/indemnities), the relevant provisions should clearly set out: 

  • the trigger event(s) that gives rise to the liability
  • the loss/liability covered
  • the timing of any payment and how the loss/liability will be calculated/determined
  • any conditions or limitations on recovery (eg obligations to mitigate, conduct of claims, etc).