Case Alert: Novolex v. Illinois Union Insurance, et al.

A recent summary judgment decision is noteworthy as one of the rare judicial opinions arising in the context of representations-and-warranties (R&W) insurance. On Jan. 12, 2024, in Novolex Holdings, LLC v. Illinois Union Insurance, et al., a New York trial court issued an opinion addressing a host of alleged representation breaches that commonly form the basis of R&W insurance claims.^[1]While the decision underscores the importance of the precise language in R&W policies and deal agreements, it also serves as a reminder that R&W insurance policies entered into by sophisticated parties may not be immune from the application of general interpretative doctrines unfavorable to insurers.

Background

In June 2018, Novolex Holdings (Novolex) closed on an acquisition of The Waddington Group (TWG), which manufactures and distributes disposable cutlery and plateware. Novolex purchased multiple layers of R&W insurance in conjunction with the deal.

In the period preceding the acquisition, TWG benefited from having Costco as its third-largest customer. Novolex alleges that, shortly after closing, it learned that Costco had — months earlier — “informed TWG of its intent to take substantially all of its business elsewhere.”^[2]Novolex contends that the events surrounding the loss of Costco’s business constituted breaches of multiple representations in the equity purchase agreement (EPA). Novolex delivered claim notices to its R&W insurers, seeking coverage of losses arising from the alleged breaches. In late 2019, Novolex sued certain insurers who declined to provide coverage.

The court’s Jan. 12 decision follows its denial of the insurers’ motions to dismiss Novolex’s complaint and years of discovery. Novolex sought summary judgment on the insurers’ liability for breach of the EPA’s material contracts representation, no material adverse effect representation, notice-of-default representation and notice-of-pending-claim representation. The insurers likewise moved for summary judgment as to those same representations, arguing that Novolex could not show any breach.

The Court’s Noteworthy Analysis

Material Contracts Representation

The court addressed the alleged breach of the EPA’s material contracts representation, which provided that, during the period preceding the transaction, there had been no written or oral notice from any of TWG’s 10 largest customers that such customer “intend[ed] to terminate, cancel or adversely and materially modify” their “Contract” with TWG. “Contract” was defined in the EPA as a “contract, agreement, license, lease, guaranty, indenture, sales or purchase order or other legally binding commitment in the nature of a contract, whether written or oral.” Novolex argued that Costco’s notice of its intent to reduce its business with TWG constituted both an intent to adversely modify its relationship with TWG and also an intent to modify its basic vendor agreement with TWG, both of which, Novolex argued, constituted breaches under the policy.

The court rejected Novolex’s arguments. First, the court said that the plain language of the representation foreclosed any argument that Costco’s plan to generally shift its business away from TWG constituted an intention to terminate, cancel or adversely modify a contract, observing that the representation “specifically applies to termination, cancellation, and modification of contracts and not of the general business relationship between TWG and Costco.”^[3]Second, the court rejected Novolex’s attempt to characterize Costco’s intent to reduce business as evidencing an intent to modify the basic vendor agreement between TWG and Costco. Under Costco’s standard terms, which were incorporated into the basic vendor agreement, the only operative contracts were the individual purchase orders themselves, and therefore any “projections, any past purchasing, prior history and representations about quantities to be purchased [we]re not binding.”^[4]Thus, a future purchase order was not a binding contract, and Costco’s decision not to enter into future purchase orders at the same volume as in the past was not a modification of the basic vendor agreement or any other contract between the parties.

Related to the material contracts representation, the court also assessed the EPA’s provision representing that TWG had not been put on notice that it was in breach of a material contract. Novolex asserted this representation was breached because TWG had provided lower prices to Costco’s competitors, which Novolex said “breach[ed]” a statement in the cover letter to Costco’s standard terms that suppliers were expected to consistently and voluntarily quote Costco the lowest possible price. Here, the court explained that Costco’s lower-price standard term was written only as an expression of policy and not as a binding contractual term. Thus, a “failure by TWG to quote the lowest prices to Costco would only be a failure to meet Costco’s expectation,” not a breach or default of any material contract.^[5]

No Material Adverse Effect Representation

The court also analyzed the EPA’s representation on material adverse effects, which provided that, during the period preceding the acquisition, “there ha[d] not been any Effect which has had or would reasonably be expected to have a Material Adverse Effect” on the business. The EPA in turn defined “Material Adverse Effect” to mean “any change, effect or event (each, an ‘Effect’) … that has been or is reasonably expected to be materially adverse to the condition (financial or otherwise) or results of operations” of TWG. Novolex argued that TWG suffered a material adverse change when Costco refused to continue to feature TWG’s products in its mailers, contending that TWG’s sales were largely driven by the inclusion of its products in the mailers.

Here, the court noted an ambiguity created by the interaction between the EPA and the “materiality scrape” provision in the insurance policy. That provision stated that “both the existence of any Breach and the amount of any Losses resulting from such Breach shall be determined without giving effect to any ‘material’, ‘materiality’, ‘Material Adverse Effect’ or similar qualification[.]”

Strictly applying the materiality scrape to the material adverse effect representation would render it meaningless by removing the entire phrase “Material Adverse Effect” from the provision. Nevertheless, relying on the general contract interpretation principle that ambiguities should be construed against the drafter — here, the insurers — and without considering the policy’s term providing that it should be construed without regard to authorship, the court applied the materiality scrape, effectively converting the “material adverse effect” representation into an “adverse effect” representation.^[6]Applying this lower bar, the court denied summary judgment for the insurers as to whether TWG’s exclusion from Costco’s mailers breached the EPA.

Causation

The court also rejected the insurers’ argument that Novolex was required to demonstrate that the alleged breaches proximately caused Novolex’s losses.^[7]The R&W policy defined “Loss” to include “the aggregate of (x) any loss, liability, demand, claim, action, cause of action, cost, damage, fee, deficiency, tax, penalty, fine, assessment, interest or expense arising out of or resulting from a Breach” (emphasis added). The court concluded that, under Delaware law, which applied to the policy, the term “arising out of” signaled a “much broader standard than proximate cause.”^[8]

Conclusion

The Novolex decision provides insight into one court’s interpretation of a R&W policy and assessment of claimed breaches. It repeatedly highlights the importance of the representations’ plain language, which will not be stretched beyond their terms. Costco’s general intent to move its business away from TWG was not an intent to modify a contract. Costco’s expression of corporate policy was written as an expectation, not a binding contractual term. And proximate cause was not an implied requirement. The plain language of the relevant documents mattered greatly. Moreover, the decision’s treatment of the materiality scrape should remind insurers to look for incongruities between the acquisition agreement and the insurance policy. Kramer Levin’s transactional insurance team will continue to monitor this case, and the R&W landscape more generally, for further developments.

^[1]_{Novolex Holdings, LLC v. Illinois Union Insurance Co., et al., Index No. 655514/2019 (N.Y. Sup. Ct.), NYSCEF Doc. No. 549.}

^[2]_{Id. at 4 – 5.}

^[3]_{Id. at 8 (emphasis added).}

^[4]_{Id. at 9.}

^[5]_{Id. at 14.}

^[6]_{Id. at 11 – 13. Many R&W insurance policies now expressly state that “Material Adverse Effect” is not subject to a materiality scrape.}

^[7]_{Id. at 17.}

^[8]_Id.