In an environment of increased volatility and uncertainty; it is more important than ever to ensure that warranties and other key share purchase agreement (SPA) provisions are drafted extremely precisely in order to ensure all clauses can be relied upon in the way that was intended by the parties to the transaction.
In M&A deals which are being negotiated currently, many buyers are placing added emphasis on the warranties and other protections they are receiving under the deal documents. In challenging economic climates, parties to transactions are typically more likely to seek to bring a claim against its counterparty, following completion of that transaction. For instance, if a buyer acquires a company which in turn performs below its expectations in the period following completion, the buyer might be more inclined to proactively review whether any warranties were breached in the SPA, and to seek to recover from the seller to mitigate this disappointing performance.
Recent case law demonstrates the importance of ensuring that the warranties are carefully considered by the sellers and are accurate – or that the Disclosure Letter fully and fairly discloses the manner in which the relevant warranty is not fully correct. The case law we consider demonstrates:
The caution that a seller should exercise in providing warranties regarding forward looking projections
That buyers should carefully consider the pitfalls of rushing or condensing their due diligence exercise in expedited sales processes, and
The care with which all parties should adhere to strict provisions surrounding a notice of claim
Subject to the negotiated protections in the transaction documents, the principle of “caveat emptor” or "buyer beware" applies to share purchase transactions. If a buyer does not carry out a robust due diligence investigation prior to buying a company, there could be significant risks or liabilities in the target business that the buyer is unaware of or does not fully understand, prior to completing the transaction.
In the case of 116 Cardamon Limited v MacAlister and another, the buyer under an SPA sought damages against the sellers of the full purchase price under the SPA. This arose as a result of an alleged breach of warranty. The claimant entered into an SPA with the defendants under which it bought 100% of the shares in Motorplus Limited. The sale was concluded quickly and the buyer performed minimal due diligence on the target or its business.
The basis of this claim was a warranty under which the sellers warranted the truth, fairness, accuracy and proper preparation of the company’s audited accounts. The sellers also warranted that the management accounts fairly represented the assets and liabilities and profit and losses of the target. The sellers warranted that the accounts were not affected by any unusual or non-recurring items or any other factors that would make the accounts misleading. These warranties were held by the court to be inaccurate to the point that the target was effectively insolvent.
The defendants attempted to rely on a limitation in the SPA, arguing that the claim had arisen as the buyer had adopted a different post completion method for valuing the liabilities. This argument was dismissed. The court held that the buyer was entitled to an award of damages amounting to the full purchase price under the SPA.
This case displays the importance of a thorough due diligence process even in an expedited sale; and also, from a sell-side perspective, the importance of accurately drafted warranties and limitations to protect the seller from claims following completion.
Financial projections warranties
Sellers will generally resist future looking warranties, particularly those that make financial projections. It is important that any warranties about future financial projections take into account the effect Covid-19 is likely to have on future business.
In Triumph Controls UK Limited & others v Primus International Holding Company & others the sellers had warranted that “so far as the Sellers are aware, the forward-looking projections relating to the companies have been honestly and carefully prepared”. The buyer brought a substantial claim against the sellers, alleging damages for breach of this warranty.
The sellers contended that they had given no warranty as to the accuracy of the projections and that they had based their projections on due and careful enquiries.
The court found for the buyer and stated that the projections failed to take into account key operational and financial assumptions that would have resulted in a lower purchase price. The judge also stated that the sellers had not taken into account recent operational difficulties which the subsidiaries had encountered.
Damages for breach of warranty were assessed by reference to the difference between the actual worth of the companies and what the court held that they would have been worth had the warranty been considered accurate, using a discounted cash flow approach.
Given the language of the warranty was so limited, this decision provides particular caution to sellers as to the dangers of giving any warranty of any nature as to financial projections.
Notification of claims
The issues surrounding notifications of claims under SPAs have repeatedly resulted in court action in recent years. It is important that provisions regarding notice of claims are drafted accurately and clearly so that there are no disputes as to the correct procedure.
“As soon as possible”
In the recent case of Towergate Financial (Group) Ltd & Ors v Hopkinson & Ors the court considered the interpretation of a contractual time limit for notifying a breach of an indemnity under the SPA. The court determined that a clause which required notice for a claim under an indemnity to be given “as soon as possible and in any event prior to… on or before the seventh anniversary of the date of this Agreement” had not been satisfied, even where the claim had been notified before the seventh anniversary. The buyer argued that the notice had been given before the seventh anniversary, that the words “as soon as possible” should be disregarded, and the claim was therefore valid. The sellers on the other hand contended that the notice was invalid as it was not given “as soon as possible” after determining there was a breach that might give rise to a claim under an indemnity in the SPA.
The court agreed with the sellers that the words “as soon as possible” could not be disregarded and that the claim was therefore invalid under the SPA.
The above case demonstrates that buyers should be conscious of the various requirements for valid notification of claims under SPAs, rather than focusing too narrowly on the time limitation.
Notification of actual claims vs possible claims
In the case of Stobart Group Ltd & Stobart Rail Ltd v Stobart & Tinkler the court had to consider whether or not a notification of a tax claim was effective. The court determined that the notice was ineffective as the buyer only notified the defendants of the existence of a possible claim. The court emphasised the difference between notifying the sellers of a possible claim and notifying the sellers of an actual claim.
When issuing a notification of claim it is important that the claim clearly states that there is in fact a claim and identifies the particular warranty or clause of the SPA that the claim arises from.
Trigger for start of notification period; and “reasonable detail” test
Notification of a claim was also the focal point in The Hut Group v Nabahar-Cookson. In this case the seller transferred its shares in the target company, Cend, to the buyer. It was the buyer’s case that the seller was in breach of a warranty relating to Cend’s management accounts. The seller had warranted in the SPA that the accounts had been prepared in a way which was consistent with that used in the preparation of Cend’s prior accounts and the past practice of the business. The seller warranted that the accounts fairly presented the assets and liabilities and profits and losses of Cend.
The court held that the seller had in fact breached the warranty but it had to consider whether the mechanics of the claim complied with the provisions in the SPA. The relevant clause in the SPA stated that “The Sellers will not be liable for any Claim unless the Buyer serves notice of the Claim on the Sellers (specifying in reasonable detail the nature of the Claim and, so far as practicable, the amount claimed in respect of it) as soon as reasonably practicable and in any event within 20 Business Days after becoming aware of the matter.” The court agreed with the buyer’s argument that it had only become “aware of the matter” at the time that it was “aware that there was a proper basis” for a warranty claim and that it had served the notice within 20 days of this, in line with the procedures set out in the SPA. The court agreed that without knowing the claim had a proper basis, a party to an SPA would not expect or wish to notify the other party of it.
Under the SPA the notice for claim of breach of warranty had to specify “in reasonable detail the nature of the claim”. The seller argued that the notice was defective as it understated the amount later claimed and did not contain information about calculations. The seller alleged that the notice inaccurately described one of the adjustments. However, the court found that the notice contained sufficient detail and stated that “not much was contractually required” to meet the “reasonable detail” threshold of the clause.
While buyers and sellers often agree to a time limit on notifying claims, the provision should be tightly drafted to avoid any ambiguity as to when the time period actually starts to run. The SPA should also explicitly state what exactly is required in a notification for it to be valid.
The above case law demonstrates:
The care that needs to be taken when preparing and warranting the management accounts
The caution that a buyer should exercise in proceeding with a transaction quickly and without a thorough due diligence process having been conducted
The dangers of future looking financial projections warranties, even where they are heavily qualified, and
The importance of a rigorous approach to drafting notice provisions and complying with their terms when issuing any notice under a SPA.
If you need further guidance about any of these issues, contact a member of our Corporate team.
The content of this article is provided for information purposes only and does not constitute legal or other advice.
  EWHC 1200
  EWHC 565 (TCC)
  EWHC 984 (Comm)
  EWCA Civ 1376
  EWCA Civ 218