If You Are Selling A Business Take Note
EQUITIX EEEF BIOMASS 2 LTD V FOX & ORS HT-2018-000335
In a significant victory for AG's client, the High Court has reiterated the legal principles applicable to the quantification of damages for breach of warranty and examined some interesting points in relation to contractual duties of mitigation and liability caps on which the Defendants sought unsuccessfully to rely.
The Claimant purchased the entire issued share capital of Gaia Heat Limited (Gaia) pursuant to a share sale agreement (the SSA). The SSA contained warranties relating to, amongst other things, compliance with environmental permits, the ability of Gaia's plant and equipment to perform its intended function, and the proper service and maintenance of these plant and equipment. The Claimant's core contention in its claim for breach of those warranties was that Gaia's plant and equipment was in a poor state of repair because the Defendants had failed to operate it properly, causing lasting damage, in order to make the company's financial performance look better to potential purchasers than in fact it was.
KEY LEGAL POINTS
Kerr J, sitting in the Technology and Construction Court, found for the Claimant and awarded it £11 million in damages, which was the liability cap stipulated in the Agreement. Key points in Kerr J's judgment were:
- It is in theory possible for a defence to a breach of warranty based on knowledge, to be based on knowledge imputed to the purchaser via its agents (including consultants engaged to assist with the purchaser's due diligence), but not where the relevant contractual provision requires "actual" knowledge and not where such provision stipulates specific individuals whose knowledge "counts" for these purposes.
- Damages for breach of a warranty of quality are to be calculated as the diminution in value of the shares attributable to the relevant breaches of warranty. The key question is how a hypothetical reasonable purchaser would have assessed the impact on the price he or she would be prepared to pay for the company in question in light of the additional commercial risk involved in the transaction represented by the undisclosed facts of which he or she had now been fixed with knowledge.
- There is no scope for the common law notion of mitigation of loss in relation to a claim for breach of warranty because the buyer has no opportunity to mitigate loss – the diminution in value of the shares is calculated on the date of completion. A clause in the Agreement seeking to impose a duty on the buyer to mitigate its loss sets a standard of conduct no higher than that imposed on it at common law, and in order to be effectual must attempt to provide expressly for the impact a breach of that duty will have on a buyer's right to damages for breach of warranty.
- A contractual liability cap drafted to include claims made "in respect of" any claim under the breach of warranty, did not include liability relating to interest and legal costs because such claims were not made in respect of the Agreement itself.
Permission was granted to appeal aspects of the judgment, but no appeal has been pursued.
The case is a stark lesson for sellers of businesses:
- The telling of half-truths in an effort to placate buyers is likely to lead to successful claims for breach of warranty. Full and fair disclosure of the true nature of the business and any issues it faces is required in order to mount a defence to a breach of warranty claim based on non-disclosure.
- The provision of information to external consultants engaged by buyers to assist with their due diligence will not assist sellers to mount a defence based on the buyer's knowledge where the sale contract makes specific provision as to the natural persons whose knowledge "counts" for that purpose.
- Even where buyers seek to limit their exposure to the risk that the business will under-perform expectations post-completion, via a deferred consideration mechanism, or the placing of some monies in escrow, the orthodox approach to the calculation of damages for breach of warranty remains to calculate the difference between the market value of the company "as warranted" (usually the total price the buyer actually agrees to pay) and the "true" market value of the company (by reference to how a hypothetical purchaser would modify his or her approach to price based on the additional risks represented by the undisclosed facts).
- Where sellers wish to limit their liability for breach of warranty and to impose contractual obligations on a buyer to mitigate its losses, clear words will be required; a contractual liability cap will not extend to cover liability for statutory interest and legal costs, unless it is expressly extended to cover them.