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A greener deal: Environmental warranties in M&A transactions

Posted on 15 August 2022

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Introduction

Environmental concerns play an increasingly important role in almost every facet of daily life and, as the Court of Appeal's recent judgment in MDW Holdings Limited v Norvill & Ors demonstrates, M&A transactions are far from immune. The decision, which concerned the assessment of damages payable for breach of environmental warranties in a share purchase agreement, considers issues which may become increasingly common for companies that seek to capitalise on their "green" credentials in order to maximise share value. In this article, we consider the Court of Appeal's judgment and implications for the future.

Background

The case concerned G.D. Environmental Services Limited (GDE), a waste disposal business which collected, processed and disposed of dry and wet waste, including hazardous waste such as leachate (liquid runoff from landfill sites). In 2015, the claimant, MDW Holdings Limited, entered into a share purchase agreement (SPA) to purchase the entire issued capital of GDE from the defendants, the Norvills.

Pursuant to the SPA, the defendants warranted that GDE had complied with applicable environmental laws and permits, and that there were no facts or circumstances which could lead to a breach of such laws or to any claims or investigations by the appropriate environmental regulators. However, at first instance, Judge Keyser QC found that prior to the SPA, GDE had provided its regulators with false information and had breached consents in relation to the discharge of leachates. Judge Keyser QC therefore concluded that the defendants had breached the warranties in the SPA and were also responsible for untrue representations regarding GDE's communications with the regulator.

It was common ground that the proper measures of damages was the "…difference between (a) the value of GDE on the basis that the warranties were true ('Warranty True') and (b) the actual value of GDE given that the warranties were false ('Warranty False')" as at the date of the SPA.

In assessing that amount, Judge Keyser QC held that the Warranty False amount should reflect the "additional costs that would have been incurred in the lawful operation of the leachate processing operations at the site and, correspondingly, the reduced profits" as well as the "reputational damage… that the breaches were liable to cause to the company and jeopardy that they occasioned to the future of the business" and ultimately awarded damages of £382,600.

The defendants appealed, arguing that the damages award took account of a risk which had not materialised by the time of trial since no prosecution had been brought by the regulators, there had been no loss of permits, and no reputational damage had been suffered by GDE's wet waste division.

The Appeal

As Lord Justice Newey noted, damages for breach of contract aim to put a wronged party in the position they would have been in had the contract been performed, and are normally assessed as at the date of the breach. Nevertheless, the courts may sometimes take account of events following the date of assessment where necessary to give effect to the overriding compensatory principle.

However, Lord Justice Newey distinguished between cases involving anticipatory breach (i.e., where a party demonstrates an unwillingness to perform), and cases involving actual breach (such as the present). He accepted that in cases where an anticipatory breach has been accepted, it is appropriate to consider what would have happened if the breach had not occurred, and in that context, events that occur after the breach may be relevant. However, that principle had no application in a case where a party has committed an actual breach. Further, where a claimant has been induced by deceit to purchase something, he observed that a defendant cannot reduce its liability by showing that a contingency which served to reduce the value of the item at the date of assessment did not eventuate. In Lord Justice Newey's view, there was a strong case for the position to be similar in respect of warranties given on a share sale, but even if there were such cases in which account could be taken of what happened after the breach in relation to a contingency taken into account when assessing damages, Lord Justice Newey considered such cases must be rare, involving situations where the buyer might otherwise be said to have gained a "windfall".

In this case Lord Justice Newey went on to confirm Judge Keyser QC's decision to assess GDE's Warranty False value as he did. Aside from reflecting the increased costs that GDE would have paid had it disposed of leachate correctly, Lord Justice Newey agreed that it was appropriate to reflect the reputational damage the breaches were likely to cause GDE, on the basis that prospective buyers would have offered less for the company were they aware of the ongoing breaches. It did not matter that reputational damage did not in fact occur following the SPA, because the value of the company had already been reduced by the misconduct prior to the SPA.

Accordingly, the Court of Appeal refused to set aside the award of damages for breach of warranty. However, the case was remitted back to the High Court to determine whether the claimant was entitled to additional damages for deceit.

Comment

Although claims under environmental warranties are currently unusual, the Court of Appeal's decision in MDW may be a sign of things to come, particularly for companies operating in industries subject to stringent environmental regulation. In share sales, target companies are acquired along with all their liabilities, including environmental liabilities which may not be quantifiable at the time of their sale, such as those incurred by GDE. Given that breaches of environmental regulations and contamination events can often go undetected for years, purchasers have their work cut out for them when carrying out due diligence. The Court of Appeal's decision should therefore be welcomed in its confirmation that potential reputational damage can be taken into consideration when assessing damages for breach of warranty, even if such damage does not in fact occur.

As companies face increasing scrutiny over their environmental credentials, the potential for significant reputational damage for a failure to comply with both the law and with public commitments is increasing. Whilst in MDW no reputational damage in fact eventuated, the court's readiness to assess damages based on potential harm is a notable warning to sellers that are not in a position to make good on their green promises. In future, environmental warranties may well become more onerous and extensive. Sellers should take particular care, both to ensure that they have complied with appropriate regulatory requirements, and that any warranties they have given are true.

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