Warranty Disclosures

A recent Court of Appeal ruling (Butcher v Pike [2021] EWCA Civ 1407) confirmed a High Court decision in favour of the sellers of a company that they were entitled to rely on disclosures made outside a disclosure letter relating to a share purchase agreement (SPA).

Background

In 2017 the sellers sold BPG (UK) Ltd (Target), an online lettings agency, to the buyers pursuant to the SPA. The Target’s main business was enabling private landlords to advertise properties for rent through on-line platforms, including Rightmove and Zoopla (the Platforms).

The buyers alleged breach of a warranty in the SPA - that the Target was not in default of any agreement to which it was a party - on the grounds that the Target had breached a restriction in the Platforms’ contractual terms preventing the Target from advertising lettings on behalf of other commercial lettings agents.

The sellers subsequently brought a claim against the buyers for unpaid deferred consideration which the sellers claimed was due to them under the SPA. The buyers argued that the sellers had breached the warranties in the SPA and that accordingly the buyers were entitled to set off the deferred consideration by way of damages.

Under the terms of the SPA:

• the warranties given by the sellers were subject only to matters 'fully, fairly and specifically disclosed' in the disclosure letter

• the liability of the sellers for warranty claims was subject to a 6 month time limit after completion

• those limitations were excluded in the case of ‘negligent nondisclosure’ in relation to the warranties (clause 6.2).

The sellers argued that they were entitled to rely on disclosures made to the buyers outside the disclosure letter and that, as the buyers were made aware of the Platforms’ terms before entering into the SPA, they could not argue there had been a non-disclosure.

The buyers accepted that they had not given the sellers notice of their warranty claim within the 6-month time limit but argued that that was irrelevant as clause 6.2 disapplied the time limit in relation to any warranty claim involving “negligent non-disclosure”. The buyers contended that the sellers' failure to disclose details of the alleged warranty breach in the disclosure letter amounted to negligent non-disclosure thereby allowing the buyers to bring a claim outside the time limit.

High Court

In the High Court, the judge held that:

• the Platforms' terms and conditions did not prevent the Target from advertising lettings on behalf of other agencies

• the sellers were entitled to rely on disclosures outside the disclosure letter for the purposes of the SPA.

The buyers appealed.

Court of Appeal

The Court of Appeal upheld the High Court's decision:

• the sellers were entitled to rely on disclosures outside the disclosure letter - clause 6.2 was not confined to disclosures made in the disclosure letter

• the reference to 'non-disclosure’ in clause 6.2 did not specifically refer to disclosures set out in the disclosure letter - its purpose was to provide exceptions to the limitations on the sellers’ liability under the SPA

• this omission was intentional, given that the disclosure letter was specifically referenced elsewhere in the SPA

• the purpose of the disclosure letter was to limit the scope of the warranties for the sellers’ benefit, whereas the purpose of clause 6.2 was to provide an exception to the limitations on liability for the buyer’s benefit.

Conclusions

The case serves to emphasise the importance of precise drafting in share purchase agreements. In particular buyers and sellers should pay particular care and attention to the drafting of warranty limitations and exclusions, and the use of references to 'disclosure’ whether as a defined or undefined term.

Warranty claims and interpretation of financial cap

A recent High Court decision considered a claim for breach of warranties in a share purchase agreement. In a broad-ranging judgment the judge considered disclosure, knowledge of the buyer and the measure of damages. A subsequent related judgment dealt with the interpretation of the liability cap on those warranties.

Background

In Equitix EEEF Biomass 2 Ltd v Fox [2021] EWHC 2531 (TCC) the High Court considered a claim for breach of warranties in a share purchase agreement (SPA) concerning the acquisition by Equitix EEEF Biomass 2 Ltd (Equitix) of the entire issued share capital of Gaia Heat Limited (Gaia), an energy company. Gaia supplied steam generated by biomass boilers to a sole customer, Greenergy Biofuels Limited (Greenergy).

The base consideration was £16.45m

The SPA was signed in December 2015 but completed in August 2016. Equitix subsequently brought proceedings against the sellers claiming that a number of warranties given by them in the SPA were false.

The sellers counterclaimed on a number of grounds, including arguing that they were owed deferred consideration.

Decision

The judge found that a number of the warranties given by the sellers in the SPA were false. He rejected the argument that the matters that rendered the warranties false had been disclosed as 'disclosed matters' under the SPA. In reaching its decision the court dealt with a number of issues:

Disclosed matters and actual knowledge

The judge considered whether Equitix had 'actual knowledge' of the relevant matters. Under the SPA Equitix confirmed that it was not 'actually aware' of any matter constituting a breach of warranty, apart from those already disclosed. For the purposes of the SPA “knowledge” was deemed to refer to matters within the ‘actual awareness’ of 2 named directors of Equitix. In considering the authorities on the meaning of 'actual knowledge', the judge highlighted the distinction (drawn in Infiniteland Ltd v Artisan Contracting Ltd) between actual knowledge and imputed or constructive knowledge:

"'actual knowledge' connotes a person’s own knowledge; as distinct from knowledge which the law attributes to him, either because he ought to have it (‘constructive knowledge’), or because it is knowledge of his agent (‘imputed knowledge’)".

The judge determined that it was for the sellers to prove that the two named directors of Equitix had actual knowledge of the matters in question, and they had failed to do so.

Value of Gaia's shares, loss and damage

In determining the measure of damages the judge contrasted breaches of warranties of “quality” and “process”. The judge noted that in the former damages are typically assessed as the difference between the ‘as warranted’ value of the shares purchased (i.e. on the basis that the warranties were correct) and their true value (i.e. the value taking into account the warranty breach), as this represents the difference between what the seller promised and what it delivered.

In contrast damages for breaches of ‘warranties of process’ are usually assessed on the basis of putting the [buyer] in the position that it would have been in had the contract not been breached.

The judge determined that here the correct measure of damages was the diminution in value of Gaia’s shares attributable to the falsity of the “warranties of quality” that had been breached. The fact that some of those warranties were of process (e.g. the assurance that the environmental permit had been complied with) did not prevent Equitix from recovering the full measure for the breaches of the warranties of quality.

The judge concluded that the true value of Gaia’s shares at completion was £1 million. The difference between their ‘as warranted’ value (£14.45 million) and their true value was £13.45 million, which was the prima facie amount of damages.

Post-completion events

The diminution in value of the shares was to be assessed at the date of completion. Any adjustment on account of later events was precluded. Although subsequent events could be considered in certain limited circumstances the judge noted that this case was not one where supervening events should be taken into account.

Failure to mitigate

As to a provision in the SPA that required Equitix to 'take all reasonable action to mitigate any loss', the judge’s view was that this did not set a standard of conduct that was any higher than the threshold imposed at common law. The onus was on the defendants (sellers) to prove a failure to mitigate, and they had been unable to do so. Risk had been allocated as between Equitix and the sellers by the warranties and there was no reason to change the share valuation based the duty to mitigate.

The judge also dismissed the defendants' counterclaims in full.

Liability cap

In a subsequent judgment (Equitix EEEF Biomass 2 Ltd v Fox & Ors [2021] EWHC 2781 (TCC)), certain consequential matters, including the interpretation of the liability cap in the SPA, were considered.

At issue was whether, on its proper construction, the financial cap on the sellers’ liability under the SPA-expressed as applying to liability “in respect of” any claim under the SPA for breach of warranty - applied to damages only, or whether it also captured interest and costs.

The sellers argued that this wording meant that the total cap included not just damages, but also costs and interest payable on both. They contended that the parties could not have intended that these ancillary obligations would be uncapped, given the broad wording used in the relevant provision.

The judge disagreed and concluded that the cap on liability applied to damages alone. A claim for interest or costs was not a claim made under the SPA itself but was brought under the court’s jurisdiction to make ancillary orders. The phrase ‘in respect of’ could not be construed as widely as, for example, ‘arising out of or in connection with’. Furthermore, the SPA made no specific mention of interest or costs, which could be expected if a party was giving up significant rights.

Conclusion

While the case was decided on its facts, it contains a useful discussion of the approach the court is likely to take with respect to

• disclosure and awareness as they relate to warranties

• appropriate measure of loss and damage in respect of claims for breach of warranty (in this case the difference between the “as warranted” market value and the true value of the shares taking into account the warranty breach)

• mitigation of loss
  

The case also serves as a further reminder of the importance of clear and precise drafting in legal agreements in avoiding potential costly disputes.

Related Expertise