UK: SPA Disputes And W&I Insurance: Guidance On Contractual Notification Clauses, Fair Disclosure And Calculating Damages

Last Updated: 27 June 2019
Article by Richard Highley and Francesca DB Muscutt

116 Cardamon Limited v MacAlister [2019] EWHC 1200 (15 May 2019) 

This recent English High Court decision produced findings on a number of issues that are relevant to claims for breaches of warranty under Share Purchase Agreements (SPAs). The case illustrates well the uncertainty and cost which so often come with making breach of warranty claims and the associated benefits of W&I insurance.

The Court decided the following issues which we analyse in this article:

  • whether a claim fails when it does not comply strictly with the notification provisions in the SPA;
  • the Seller's defence of "fair disclosure" in relation to matters not clear from the disclosure given by the Seller; and
  • the approach towards calculating damages for breach of warranty when the Buyer has underpaid for the company i.e. calculating the "as warranted" value in such circumstances.

The Facts

The Seller agreed to sell its family run insurance business for a significant discount (£2.386m against an initial asking price of £5m). The discount reflected that the Seller needed to complete quickly to avoid a large tax payment on inter-company loans which would otherwise become payable, and it was agreed the Buyer would undertake little due diligence.

The Buyer thought it was paying less than market value for the company, but shortly after completion in May 2014, material accounting issues were discovered which led to the prior, 2014 year accounts being restated, and the audited 2015 year accounts recording large prior year adjustments.

Relying on the warranties in the SPA, the Buyer served a Letter of Claim in May 2016 (within the 2 years limitation clause in the SPA) and commenced proceedings with a detailed Particulars of Claim served in December 2016.

Notification issues

The SPA Notice clause provided:

"... 6.3 The Seller shall not be liable for a Claim unless notice in writing of the Claim, summarising the nature of the Claim (in so far as it is known to the Buyer) and, as far as reasonably practicable, the amount claimed, has been given by or on behalf of the Buyer to the Seller...on or before the second anniversary of completion."

The Seller argued that the Buyer's Broker remuneration claim was barred because it was not properly notified within the 2 year anniversary period. The Letter of Claim, served within 2 years of completion, alleged that the Seller had breached Warranty 11.4 (misleading accounts) by failing to disclose a change in the basis on which broker commission was paid, meaning the company appeared more profitable in the 2014 Accounts than was the case. However, the Particulars of Claim, served after the 2 year limitation period had expired, alleged that by failing to disclose the change in the basis on which broker commission charges would be paid, the Seller had breached Warranty 11.3, namely there were no "unusual or non-recurring items" in the Accounts.

The Court held the claim was barred. It found the two allegations of breaches of warranty in the Letter of Claim and the Particulars of Claim were different in nature, and the pleaded claim (based on Warranty 11.3) had not been "summarised" in the Buyer's claim Notice within the 2 year anniversary of completion, as required by the SPA Notice Clause.

Comment: We commented on SPA notification requirements in our article on the recent case of  Hopkinson - "Defects in notification" type defences frequently appear in SPA disputes. Such defences are often technical and may not have obvious merit, and are less likely to be run by W&I insurers as a result. However, the importance of the Notice clause cannot be ignored – notification requirements are often expressed as a "condition precedent" to the Seller's liability ("the Seller shall not be liable unless notice is given...") and the courts will strictly enforce the clause, as it did in this case.

Fair disclosure defences and (i) the inter-company loan; and (ii) the broker remuneration claim.

(i) the inter-company loan

The issue concerned whether a defence of fair disclosure applied to a substantial inter-company loan which had to be written off shortly after completion. In the transaction documentation 'Disclosed' was defined as "fairly disclosed (with sufficient details to identify the nature and scope of the matter disclosed) in or under the Disclosure Letter".

The court found the loan had been fairly disclosed. In the Disclosure Letter the parties acknowledged that "all communications between the parties and their advisers are treated as disclosed" and an email from the Seller sent before completion to the Buyer's advisers stated that "..  it's likely the remaining [inter-company loan] balance will be written off". Given the correspondence acknowledged that the loan might be irrecoverable, it is unsurprising that the court found there had been fair disclosure and this element of the claim failed.

Comment: We do not believe technical defences which lack prima facie merit will be a feature of W&I insurance. It is also interesting to contrast this straightforward disclosure to the disclosure arguments deployed by the Seller in relation to the Broker remuneration claim.

(ii) the Broker remuneration claim

The Seller argued that a change in the model of remunerating brokers (which the Buyer argued was in breach of Warranty 11.3) had been fairly disclosed to the Buyer through (i) its own background knowledge of relevant industry legislation (LASPO), which was an insurance industry wide issue and (ii) the previous year Accounts had referred to LASPO's potential impact in general terms, and recorded a £1m increase in "pre-payments and accrued income".

The court found there had not been fair disclosure. The evidence from the experts was that, whilst it was possible to infer from the information in the Accounts that there might be a change in the basis on which brokers were remunerated, it was not the only inference that might be drawn. The court concluded that where, as here, there was more than one possible inference to be drawn from the Accounts, there had to be specific disclosure for there to be "fair disclosure" of the issue.

Comment: As with many of the arguments which arise in SPA disputes, so much depends on the wording of the relevant test in the SPA. In this case, disclosure had to be "fair" and the lack of specific disclosure of the broker remuneration issue was fatal to the defence of "fair disclosure". When accounting experts can take different views on what information has been disclosed to the Buyer and therefore whether a claim is valid, how to deal with such issues is likely to be one of the greatest challenges for W&I insurance. The success of the product over recent years is based in part on a belief by Insureds that they are buying a product which will avoid lengthy and costly disputes.

Under-provisioning in respect of FamilyPlus claims

The Buyer alleged that there was c.£2.2m of under-provisioning in the Accounts in respect of claims under policies of household legal expenses insurance (a scheme called "FamilyPlus"). The court agreed there was a breach of Warranty.

The difficulty for the court was that the experts were unable to agree a reliable method for calculating this under-provision and to which accounting year the error should fall. The court considered it had two options: (i) to find the claimant had failed to prove its claim, or (ii) following previous case authorities, form a view as best it could based upon available (albeit incomplete) evidence. It chose the latter, undertaking a rough and ready exercise to arrive at the correct level of provisioning in the 2013 year on the "balance of probabilities".

Comment: The court's chosen approach, where there is loss but the quantum is uncertain because of lack of evidence, we believe typifies the benefits of choosing W&I insurance cover. The lack of evidence meant not only was the outcome uncertain and the claim might have failed altogether, but that a battle of the experts at trial was predictable. Insurers require an Insured to "prove its claim" under the Policy but, in our experience, insurers will also do their best to arrive at a sensible commercial adjustment of a claim.

The measure of damages where a Buyer has paid less than market value

The normal measure of damages will be the difference between (i) the 'as warranted' value (almost invariably, the court will find this is the same as the purchase price agreed under the SPA) and (ii) the 'true value' of the company as affected by the various breaches of warranty.

The Seller's position was that the purchase price was the best evidence of the "as warranted value". However, the evidence in this case, in contrast to most cases before the courts, showed the parties had deliberately agreed a purchase price which was less than market value in return for a swift purchase without the usual due diligence process. In these circumstances, the "as warranted" value was indeed higher than the purchase price.

The SPA contained a de minimis floor so that the first £500,000 of any warranty claim was irrecoverable and a cap limiting the Seller's liability to the purchase price of £2.386m. The court ultimately awarded the Buyer the entire purchase price of £2.386m. Damages were not reduced by the £500,000 floor because it found that the Buyer's actual damages were at least £500,000 more than the warranty cap in the SPA, which was set at the level of the purchase price.

Comment: We do not think this case should be seen as changing the standard approach of the courts, which will normally accept the purchase price as the best evidence of the "as warranted" value. The facts in this case, which included a purchase undertaken without due diligence, are unusual. W&I insurers should be alert to "good bargain" type arguments where the Buyer/Insured might seek to augment its damages claim arguing that the "as warranted" value is higher than the purchase price because the Buyer argues it had purchased the company at a discount. It is also important to note that a de minimis limitation provision that seeks to make the Buyer bear the first part of the loss, may not reduce the Seller's liability for warranty claims where the overall claim value significantly exceeds any warranty cap. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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