Annabel Thomas, Partner, Dispute Resolution
Mishcon de Reya
Welcome to the latest Mishcon Academy Digital Session. We are absolutely delighted today to be joined by Laura Chandler, Corporate Partner at Mishcon and Ben Woolgar, our leading Barrister at Brick Court Chambers, and today’s topic of discussion is breach of warranty claims and also misrepresentation because the two often go hand-in-hand. An observation we have had since Covid started is we are already seeing quite a few breach of warranty claims and breach of indemnity claims sort of trickling through but since Covid really kicked in and Brexit is approaching, we’re seeing more enquiries about breach of warranty claims either kind of sellers who have bought a company and now they’ve had it and had a chance to really look into it, there are issues arising but also clients who have received a notification of a breach of warranty. So, we expect this trend to carry on and there to be more cases like this and we thought it a good opportunity to go back to basics on breach of warranty but from a corporate lawyer’s perspective so, Laura you’ve spent a lot of time negotiating things for buyers and for sellers and making sure those breach of warranties are either as wide as possible or as tight as possible and I think we’ll start off by finding out from you actually precisely what are they, why are they important and how do you negotiate them?
Laura Chandler, Corporate Partner
Mishcon de Reya
So, I suppose starting from the very beginning, what is a warranty? So, a warranty is a statement of fact so you might have a warranty that the company, the target company, is not involved in any litigation or any disputes. Should it turn out that that statement is not true, the buyer would then look to bring a warranty claim for breach of that warranty, i.e. there is some dispute or there is some litigation that they weren’t made aware of and therefore they will need to show that they suffered loss and they will bring a warranty claim accordingly. From a seller perspective it’s about telling them everything and from a buyer perspective it’s about finding out as much as you possibly can and if things don’t make sense go back and ask or your lawyers will go back and ask, it’s a… before you actually sign on the dotted line you should be finding out as much as possible about the company and the warranties then back up that due diligence process so they’re not a substitute for, you shouldn’t be saying it’s fine, I’m not really going to look under the bonnet of this because I’ve got 25 pages of warranties being given by sellers because you can quite quickly come unstuck if for example the seller has no substance, they’ve taken all of the cash out that you’ve given for this purchase and you’re chasing either an empty shell or you’re chasing individuals that have sort of syphoned off their money and put it somewhere that you can’t reach and so much better that you know exactly what you’re buying from the outset and that you’re not then trying to chase to try and recover some of the money that you’ve paid across.
Annabel Thomas, Partner, Dispute Resolution
Mishcon de Reya
Is it sufficient for a seller to say look there are these five documents dotted around the data room and actually if you look at them all in context in the right order, the buyer would have been able to work that out, I mean, Ben from your perspective is that… would that be a good defence?
Ben Woolgar, Barrister
Brick Court Chambers
It would rarely be a sensible strategy. It would depend on the particular construction of the warranties but normally in share sale agreements it’s important to remember that the data room, the contents of the data room don’t modify the express warranty so, if you have said, for instance, you’ve got a no litigation type warranty in your share sale agreement and buried in the data room actually there are, there is a claim form from somebody that shows that there was this once piece of litigation that won’t be a defence because it’s a promise that a particular state of affairs is true actually not withstanding what is true in the underlying facts.
Laura Chandler, Corporate Partner
Mishcon de Reya
And just following up on that Annabel, one of the things that as a corporate lawyer we spend quality time arguing over with purchase agreements is ‘What is the definition of disclosed?’ so, the seller gives a warranty and then sitting alongside that warranty is something called the disclosure letter and in that disclosure letter you give specific facts so if for example on that piece of… on the litigation warranty that I flagged, if there is a piece of litigation as Ben says, shoving a document in a data room that, you know, sometimes can run to, you know, thousands of documents, shoving the document in there and there’s a piece of litigation, it isn’t really going to do it. Much better to say in the disclosure letter, “There is this piece of litigation, please look at document 7.2.13 in the data room and that will provide details on it.”
Annabel Thomas, Partner, Dispute Resolution
Mishcon de Reya
What about the claims notification clause because I’ve seen a variety of different ones over the years and obviously the key thing for any Claimant is that you need to stick to that as close as possible but from a negotiating non-contentious perspective.
Laura Chandler, Corporate Partner
Mishcon de Reya
So, often the claims notification piece will sit hand-in-hand with the limitations of liability for the sellers so you will look at, or if you are acting for the seller, you will look at limiting the period in which a claim can be bought to a certain period, so let’s say for general warranties typically you might see it being somewhere between twelve months and three years. For tax warranties, somewhere between four and seven years and within that schedule also you have the mechanism that says how you have to go about notifying the other side of a claim so again from the buyer’s perspective you would say well if I become aware of a claim provided they tell you about it before the claim period’s up, that’s fine, from the seller’s perspective they will say no, no, no you need to… as soon as you become of this you need to tell us about it and if you don’t then actually issue proceedings within six months, nine months whatever it might be then that’s dead, that drops dead.
Annabel Thomas, Partner, Dispute Resolution
Mishcon de Reya
There’s a long line of cases going to opt out because they haven’t followed the notification provisions of the SPA so I think you’re absolutely right, when we’re drafting notification letters, that’s something we have absolutely in the forefront of our minds. And Ben so from a case law perspective, what’s the… where do you see the sort of developing trends on that?
Ben Woolgar, Barrister
Brick Court Chambers
I think one of the probably the biggest trend in this area concerns what needs to go into a notification letter to constitute a proper notification. It’s quite rare to have a dispute about whether or not a notification was made in time but what you often do get an argument about is that the notification clause will contain some particular criteria for what the notification has to contain. It often says something like ‘In reasonable detail and indicating the likely level of damages claimed’ or words to that effect but the Courts have generally been quite lenient with what actually needs to go into a notification letter, they have normally taken a fairly generous approach. The reason for that is that they say the whole purpose of these clauses is not necessarily to activate the dispute at this stage but simply to tell the sellers who much they need to make provision for in their accounts, how much cash they need to set aside for these breach of warranty clauses.
Annabel Thomas, Partner, Dispute Resolution
Mishcon de Reya
And Laura, what’s the… your experience? Is the common provision, do people treat it by way of Escrow monies of how, what are the kind of trends in terms of SPA and how you deal with breach of warranty claims? Do people use Escrow accounts?
Laura Chandler, Corporate Partner
Mishcon de Reya
They do but not generally for warranty claims. So, if there is an issue so let’s say we’ve agreed a 10 million purchase and actually our diligence we find there’s a, you know, half a million pound hole, then it might well be that actually before you even sign on the line, buyer and seller have another discussion and buyer says “That 10 million now is 9.5 and this is why” and seller says, “Mmm, call it 9.6 and you know you’ve got a deal” and you sort of do a horse trade before you actually sign on the line and that’s done. If there’s potentially a piece of litigation lurking in the background what you will likely do at that stage is say, “Mmm, I’m going to ask for a specific indemnity in relation to that potentially no liability” and that’s when you will start to talk about Escrows because it’s something that you know could very well materialise so it’s a known piece and so you might say, “Look, I’ve gone away and had a look at this and we think potentially this litigation could be to the tune of £250,000 therefore we’re going to hold back £250,000 of the purchase price and we’re going to put it in Escrow and as and when that piece of litigation is decided either way, the money is there”, we’ve not go to go chasing seller through wherever it is to get the money back. In terms of warranties, of course, if through the disclosure process the seller has made you known of an issue with the warranties and you decided not to push for an indemnity then your claim is, you know, your claim is not going to be forthcoming for a breach of warranty claim because in essence they’ve disclosed against it and you’ve not got it. So this is why with warranties, it’s the position sort of, of last resort almost. You’ve gone through diligence, you’ve gone through disclosure, you’ve worked out whether there is anything that needs to be knocked off the purchase price, strike one. You’ve worked out if there is any specific indemnities that you need, potentially backed by and Escrow, strike two. The warranties are therefore anything that’s not cropped up through that whole process and therefore you… it would be unusual to say just in case there’s something else, I’m going to put something in an Escrow and so you are to the extent, you’ve got a warranty claim largely chasing the seller who has obviously, you know, taken the money that you’ve paid across as a purchaser and you are hoping that that money is still around and that you can still claim it.
Annabel Thomas, Partner, Dispute Resolution
Mishcon de Reya
And I think that brings us onto remedies. Do you want to talk us through the remedies for breach of warranty cases?
Ben Woolgar, Barrister
Brick Court Chambers
You calculate damages for a breach of warranty claim in a share sale or asset sale agreement on the basis of the difference between what you actually paid for the business and what the business was worth in truth. The reason that that is important is that sometimes you have a case where somebody has warranted profits of £30 million a year and the true level of profits are £20 million a year and the buyer gets hold of the business and they say “Oh great, there’s a gap of £10 million, I must be entitled to that whole difference” but it’s not that simple because the way you calculate damages is on the basis of the value of the business and so instead what you will normally end up doing is getting forensic accountants crawling all over the business and trying to work out what the basis of the valuation acquisition was and what the right basis to value it on is now and often there’ll be questions about whether or not the right basis is a net asset valuation basis or a discounted cash flow basis etcetera.
Annabel Thomas, Partner, Dispute Resolution
Mishcon de Reya
This brings me onto claims for misrepresentation which sort of correlate really with the increasing number of 11.34 increasing number of enquiries about misrepresentation in particular. I wondered if you would just briefly talk us through the different types of misrep on the test, and the remedy for each one.
Ben Woolgar, Barrister
Brick Court Chambers
There are three different types of misrepresentation at the most basic level and they are innocence, negligence and fraudulence. So we define misrepresentation cases essentially by the level of culpability of the person who made the representation and that’s important because there are then different requirements for showing loss and what remedies are available for each type. In an innocent misrepresentation case, the most simple case, a vendor has made a certain representation about the state of their business and actually that wasn’t true but either they couldn’t have known that at all or they couldn’t have known it with reasonable diligence. The second category is negligent misrepresentation and this is where you said the thing and you didn’t know that it was false when you made the representation but you essentially could have known if you had exercised reasonable diligence to find out. But the paradigm case that you really see in a commercial context and by the far the most common and interesting misrepresentation claims in commercial settings are fraudulent misrepresentation cases. So, very briefly I’m just going to run through the elements of a fraudulent misrepresentation using a very simple example from a share sale context. So you need essentially 5.5 things to prove fraudulent misrepresentation. First, you need a representation so to take a very simple example, the seller needs to have said “My business had profits of £1 million last year” and you will then get into arguments often about whether or not a particular word that somebody said did actually constitute a representation of a particular fact. Second, the representation needs to be false; the business, let’s say, only had profits of half a million pounds last year. Third, the seller needs to have intended that the purchaser should rely on that representation so, sometimes you get the case where the transaction was cooked up in the wine bar and the very brash businessman said “Ah mate, you know, I’ve got this great new product line and it’s making me four million quid a year” and everybody was a few drinks deep and in fact, nobody really ever intended that that sort of statement would have legal consequences. Now that said, in a fraud case intention to rely is presumed because if you knew what you were saying is untrue, the Court unsurprisingly takes a very generous approach. Fourth, you need the person making the representation to have been fraudulent; that means they knew the representation was false or they were reckless as to its truth, i.e. they didn’t care so, the person making the claim that their business had a million pounds of profits last year, might just never have looked at the management accounts for that business, they didn’t know what they were saying was false in the sense that it wasn’t present to their mind but they were telling a lie but that is still fraud for the purposes of a deceit claim. Fifth, the purchaser has to have relied on the representation; essentially you have to ask yourself the question “What would I have done if I had been told the truth?” Now this is a surprisingly fertile ground for arguments in commercial cases. You frankly often get situations where the reason the person was buying the company was simply nothing to do with the representation that was being made even though the representation was a flagrant lie. So those are the five full requirements. The reason I said that there’s a half requirement is that there are essentially two remedies in a fraudulent misrepresentation case; either you can rescind the transaction and that means the whole contract is unwound, you give back the shares and you are repaid the money that you paid to acquire the business or, and often rescission in these cases has become impossible because the business has already changed, you sue for damages, and if you are in the suing for damages territory then you also need to prove that you have suffered loss as a result of the deceit but that’s not a full requirement because sometimes you are simply saying “When I know of this fraud, I would never have done this deal, that’s why I want to be able to rescind even though I haven’t actually lost any money by acquiring these shares.”
Annabel Thomas, Partner, Dispute Resolution
Mishcon de Reya
I think it’s worth pointing out that this jurisdiction does differ from others in that we can’t professionally plead fraud unless there’s a proper basis to be doing so. But in terms of evidencing, reliance and evidence, inducement and all those kind of things, that is where it does become quite complex and you are very heavily reliant upon disclosure and what comes up and how people documented their negotiations.
Ben Woolgar, Barrister
Brick Court Chambers
Absolutely, and I think reliance often is a very unusual stage of litigation to get to for business people because they perfectly reasonably say “Well, I was lied to. I was lied to about this business that I was buying” and ultimately it is a subjective question of what was actually in the decision-maker’s mind at the time they made the decision and that can feel very unusual to find themselves giving evidence about that and sometimes you are purely reliant on your client’s raw evidence but what you really want and what you need to collate is all of the evidence of your decision-making processes so, what did you say to the board, what was in the board paper when you explained the rationale for the transaction, what were your accountants and your consultants saying in their reports about the business when you were reaching that decision, what projections were they making and what projections were you looking at about cashflow or net assets and so on?
Annabel Thomas, Partner, Dispute Resolution
Mishcon de Reya
How long are you talking about for say a kind of fairly straight forward acquisition? How long would you spend negotiating a breach of the warranty indemnity sections?
Laura Chandler, Corporate Partner
Mishcon de Reya
These things can be done fairly quickly if you’ve got sophisticated buyer/seller and the commercial terms are agreed and there isn’t a lot of work to do on disclosure and diligence, equally if you’ve got a very complicated company or you are going through big processes or there are other things going on, it can also, you know, it can take quite a while. I mean one thing that’s interesting now that we’re seeing more and more is the use of warranty indemnity insurance. It used to be much more used for property SPV deals where you have a corporate that just holds the property and less so for trading but actually we’re finding more and more now because there are many more providers of the insurance that the prices are coming down. It doesn’t mean that you don’t do the disclosure process, it doesn’t mean that you don’t do the diligence process, the insurers want to see that all that has been done as diligently as it would have been done if you were going to have to put your hand in your pocket had there been a claim but actually it is just, you know, for ample amount of money it means that the sellers can, you know, get to wherever it is they are going off to if that was their plan knowing that, save in the event of fraud or wilful concealment that actually they are home and hosed should there be a claim that actually it’s a claim that they would need to be… that the buyer would need to be making against the insurance policy not against the sellers themselves.
Annabel Thomas, Partner, Dispute Resolution
Mishcon de Reya
Ben, one… I think one last thing while we just have a few minutes left is the recent Marex decision. What did that change in the plan a bit and I wondered if you wanted to say a few words on that?
Ben Woolgar, Barrister
Brick Court Chambers
Marex is a decision about what is called in company law, the reflective loss principle. Basically, in very simple terms what this is, is that where you are a shareholder in a company and a wrong has been done to the company and your only loss is a fall in the value of your shareholding in the company, you personally do not have a claim; the claim belongs to the company and this comes up a lot both in the deceit context where, for instance, you often have problems with empty shell companies at some point in the chain and what somebody really wants to do is recover their personal losses. It also often comes up in the asset stripping context where somebody has basically stripped the assets out of the entity that otherwise would have been on the hook and Marex is a particularly interesting but also egregious example of that because what happened in Marex was that there was a contractual claim brought by Marex against a company, it was BVI company, the parties received draft judgement on that claim from the Court and normally when you get judgement from the Court you actually receive it in draft three or four days beforehand for the lawyers to suggest corrections and to deal with kind of consequential matters and so on, and Mr Seveilleja, who was the Defendant in Marex, was also the sole shareholder of the company, and what he did was simply transfer every penny out of the company’s bank account into his personal bank account upon the receipt of draft judgement so that the contractual claim for about £7 or £8 million succeeded but there was no way of recovering on it. Unsurprisingly, the Supreme Court took a dim view of this conduct and was not enthusiastic about the idea of letting him get away with that behaviour but his defence was “You, the creditor, Marex, don’t have a claim against me personally because what I did was wrongfully take money out of the company and that is a claim that belongs to the company.” What the Supreme Court said is, “No, the reflective loss principle only applies in a narrow set of cases to do with shareholders of the company.” It doesn’t prevent recovery in conspiracy for instance on behalf of an individual where they are only a creditor and not a shareholder. So, how is that relevant here? Well, suppose you’ve bought a company from another company and that company now has no assets and in the course of the negotiations, various representations were made to you and they turned out to be false, you can now undoubtedly sue the individuals for asset stripping thereby causing you not to recover on your breach of warranty or deceit claim in a way that was previously unclear.
Annabel Thomas, Partner, Dispute Resolution
Mishcon de Reya
I think that is all we’ve got time for today but from Laura and from me at Mishcon de Reya, a huge thank you to Ben Woolgar of Brick Court for joining us today. Thank you very, very much.
Ben Woolgar, Barrister
Brick Court Chambers
Thanks so much guys.
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