Transfer of Shares in an Insurance Company – Liability of the Seller for “Hidden Liabilities”

An important issue in transactions involving the transfer of shares in an insurance company is the warranty for “hidden liabilities”, an expression that is far from easy to define. Good practice advises to agree to clauses by which the seller represents and warrants to the buyer that there are no unreported liabilities.

Nevertheless, the inclusion of this type of clauses in a share purchase agreement is still subject to construction issues, as shown by a recent ruling of the CSJN.

In re “Pocovi, Osmar Miguel and others v. Brennan, Horacio Marcelo Santos and others”, the CSJN admitted the petition in error filled by the plaintiff against a ruling from the Commercial Court of Appeals that had narrowly construed a warranty clause in a stock purchase agreement, restricting –up to almost nullifying– its scope.

On January 8, 1985 the parties entered into a stock purchase agreement in connection with the shares of Compañía de Seguros Unión Comerciantes S.A. Under this contract: a) the buyers stated that they had full knowledge of the assets and liabilities of the company as of the day of execution of the agreement (sixth clause); b) the sellers made themselves joint and severally liable for any hidden liabilities or lack of assets at the date of the agreement, in accordance with an annex signed separately (seventh clause); and c) the sellers represented that they were not aware of any other claim against Compañía de Seguros Unión Comerciantes S.A. than those detailed in an annex (ninth clause).

Plaintiffs filed a complaint to recover the amounts paid in respect of alleged hidden liabilities –consisting on claims that had not been declared in the annex to the agreement.

Tribunal E of the Commercial Court of Appeals rejected the claim. The Court of Appeals defined “hidden liabilities” as those that do exist but are not recorded on a company’s accounting records. To the Court of Appeals, as a condition, this requires that the sellers must have known and willfully or negligently hidden such liabilities from the company’s accounting records.

The Court of Appeals found that the defendants had not incurred in any “illegality” by declaring their ignorance about the existence of complaints other than those listed in the agreement, because it had not been established that the insurer had been notified about such lawsuits before celebrating the share purchase agreement.

On May 28, 2008 the CSJN found this ruling of the Tribunal E of the Commercial Court of Appeals to be arbitrary. The CSJN held that the meaning given by the Court of Appeals to the expression “hidden liabilities” was not grounded on the wording of the contract which, on the contrary, required a broader construction. Therefore, the CSJN remanded the case for a new ruling by the Court of Appeals.

Notwithstanding this ruling from the CSJN, on March 17, 2009 the Commercial Court of Appeals once again rejected the complaint. This time the Court of Appeals held that in order to render effective the warranty it did not matter the date a loss was reported to the company or the date when the complaint was filed, but the date when the insurer was served with the corresponding notice of process. In any case, even though it was found that eight lawsuits had been omitted from the annex notwithstanding that the insurer had been served with the complaints prior to the transfer of the shares, the Court of Appeals held that it was inappropriate to enforce the warranty inasmuch the buyers had not evidenced what percentage of the amounts paid had been recovered from the reinsurer.

The plaintiffs filed another appeal against this ruling that was rejected by the Commercial Court of Appeals. Finally they filled a new petition in error before the CSJN.

On May 24, 2011, the CSJN admitted the appeal and ordered a new ruling. The CSJN held that the requirement imposed by the Court of Appeals in order to enforce the warranty (i.e., evidence that the claims had been served before the share purchase agreement) implied incorporating into the stock purchase agreement a subjective factor (i.e. negligence) that had not been included by the parties to their agreement (the sellers had made their representation over hidden liabilities without reservations).

It may thus be concluded that the warranty clause for hidden liabilities may be subject to different constructions depending on its wording and the scope that the parties assigned to it during the negotiations of the agreement, as well as on their subsequent behavior. Therefore, in addition to conducting a thorough due diligence process before entering into this sort of transactions, it is very important to pay special attention to the drafting of the stock purchase agreement in order to clearly state the intention of the parties, so that in the event of a dispute, it may be construed consistently with such intention.