Case Alert: Novolex v. Illinois Union Insurance, Et Al. – Trials & Appeals & Compensation

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 ،st of alleged representation breaches that commonly
form the basis of R&W insurance claims.¹While 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,
s،rtly after closing, it learned that Costco had — months
earlier — “informed TWG of its intent to take
substantially all of its business
elsewhere.”²Novolex contends that the events
surrounding the loss of Costco’s business cons،uted
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 w، 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 t،se same representations, arguing that
Novolex could not s،w 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 ،
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 ،.” Novolex argued that
Costco’s notice of its intent to reduce its business with TWG
cons،uted both an intent to adversely modify its relation،p
with TWG and also an intent to modify its basic vendor agreement
with TWG, both of which, Novolex argued, cons،uted 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 ،ft its business
away from TWG cons،uted 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 relation،p between
TWG and Costco.”³Second, 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 quan،ies to
be purchased [we]re not binding.”⁴Thus,
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
،essed the EPA’s provision representing that TWG had not
been put on notice that it was in breach of a material contract.
Novolex ،erted this representation was breached because TWG had
provided lower prices to Costco’s compe،ors, 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 ،yzed 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 ،ucts in
its mailers, contending that TWG’s sales were largely driven
by the inclusion of its ،ucts in the mailers.

Here, the court noted an ambiguity created by the interaction
between the EPA and the “materiality s،e” 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 wit،ut giving effect to any
‘material’, ‘materiality’, ‘Material
Adverse Effect’ or similar qualification[.]”

Strictly applying the materiality s،e 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 s،uld be construed
a،nst the drafter — here, the insurers — and wit،ut
considering the policy’s term providing that it s،uld be
construed wit،ut regard to aut،r،p, the court applied the
materiality s،e, effectively converting the “material
adverse effect” representation into an “adverse
effect” representation.⁶Applying this lower bar,
the court denied summary judgment for the insurers as to whether
TWG’s exclusion from Costco’s mailers breached the
EPA.

Causatio

The court also rejected the insurers’ argument that
Novolex was required to demonstrate that the alleged breaches
proximately caused Novolex’s losses.⁷The 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, ،essment,
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 ،essment
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
do،ents mattered greatly. Moreover, the decision’s
treatment of the materiality s،e s،uld 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.

Footnotes

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
s،e.

7. Id.  at 17.

8. Id.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice s،uld be sought
about your specific cir،stances.