Legal Briefing

When is a notice of breach of warranty good enough?

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Dispute resolution | 01 April 2015

The increase in M&A transactions which many firms have seen in recent times will inevitably spawn a rise in the disputes which follow when a buyer has not bought quite what it had bargained for. The extent of the warranty given by a seller is an important element of the transaction and the value to the buyer of a business. And if the warranty is breached, the buyer will need to be confident that it can enforce its warranties. 


In a recent case (The Hut Group Ltd v Nobahar-Cookson [2014]), involving a dispute following the acquisition of My Protein, an online sports nutrition business, there were claims and counterclaims for breach of warranties given in the sale and purchase documentation. The dispute was wide ranging. Two particular issues the Court had to grapple with will be of interest to companies and their lawyers who are engaged in M&A. These were the requirements for a notice given to trigger the breach of warranty claim, and the calculation of damages for the breach of warranty. The Court also considered the circumstances in which acts and omissions (in this case, fraud) by natural persons can be attributed to a company.

BACKGROUND

The Hut Group Limited (THG), an online retailer, was the claimant and the defendants were Oliver Nobahar-Cookson and Barclays Private Bank and Trust Ltd, the trustee of Cookson’s family Trust in Jersey. In 2011, THG bought the My Protein business which was the trading name of a company, Cend, which was owned by the defendants. The transaction took place pursuant to a share purchase agreement of May 2011. As part of the deal, the defendants transferred their shares in Cend to THG which in turn provided equity in the combined business to the Trust, in the form of shares in THG. The defendants also received cash consideration which was shared between them.

THG’s claim

It was THG’s case that the defendants were in breach of a warranty relating to Cend’s management accounts. The defendants had warranted in the share purchase agreement that those accounts had been prepared in a way which was consistent with the preparation of its statutory accounts, and gave a true and fair view of the company’s financial position. THG claimed that in fact seven adjustments to the accounts were required in order for them to comply with the warranty.

The defendants rejected the claim, contending that:

  • THG’s warranty claim was time barred because THG had not complied with the notice provision in the share purchase agreement concerning its claim. This provision stipulated that the buyer should serve notice of the claim, specifying in reasonable detail the nature of the claim (and, so far as practicable, the amount claimed), within 20 business days of becoming aware of the matter. The defendants argued that, on the proper construction of this provision, THG was required to give notice when it became apparent that it might have a claim. On this construction, it had failed to notify the defendants of its claim in time. THG argued that it was required to notify the defendants only when it became aware that it had a proper basis to make an actionable claim.
  • The notice given by THG was invalid, because it did not contain sufficient detail. It understated the amount claimed (for tactical reasons) and contained no information about the basis of the calculation.
Defendants’ counterclaim

The trustee of the second defendant Trust brought a counterclaim in relation to the value of the consideration shares in THG. The trustee claimed that THG was in breach of the warranties it had given concerning THG’s accounts and management accounts. Liability for this breach was admitted by THG. The breach was caused by an accounting fraud by THG’s financial controller (leading to the company’s earnings before interest, taxes, depreciation and amortisation (EBITDA) being overstated by £5.6m). THG contended, however, that the fraud could not be attributed to the company, so that a £7.24m contractual cap on its liability under the share purchase agreement applied.

DECISION

THG’s notice of claim

The Court held that, on the facts, the defendants had breached the warranty relating to Cend’s management accounts. The Court had to consider, however, whether THG’s notice of claim for breach of warranty complied with the provisions of the share purchase agreement, both as to its timing and as to its content.

Allegation of late notification

Had THG had given a notice under the share purchase agreement in time to trigger the liability for the breach? The Court agreed with THG’s contention that it only became ‘aware of the matter’, for the purposes of the commencement of the 20-day period within which the notice of claim had to be given, at the point at which it was ‘aware that there was a proper basis’ for putting forward a warranty claim. This was commercial sense. Without knowing that a claim has a proper basis, a party to a share purchase agreement would not expect or wish to notify the other party of it. In other words, it cannot have been the parties’ intention to require notice to be given every time a party became aware of facts which might form the basis of a breach of warranty claim.

The adequacy of THG’s notice

Under the share purchase agreement the notice of claim for breach of warranty had to specify ‘in reasonable detail the nature of the claim’. The breach concerned accounting adjustments which would be required in order for the accounts fairly to reflect Cend’s financial position. The defendants argued that the notice was defective in that it understated the amount later claimed, did not contain information about the basis of the calculation and inaccurately described one of the adjustments. The Court found, however, that the notice given by THG contained sufficient detail of the claim and thereby complied with the share purchase agreement’s requirements as to the content of the notice. The Court stated that ‘not much was contractually required’ to meet the ‘reasonable detail’ threshold of the clause, and that THG had provided all that was practicable by way of quantification at this stage.

Quantum of THG’s claim

As to the measure of damages for THG’s claim for breach of warranty, it was common ground that any loss suffered by THG would be quantified as the difference between:

  • the ‘warranty true’ valuation of Cend (ie, assuming no breach of warranty); and
  • the ‘warranty false’ valuation of Cend (ie, assuming the accounts warranties were false to the extent that the adjustments contended for were necessary).

It was common ground that Cend’s warranty false value was an arithmetical exercise which should be calculated by reference to a multiple of Cend’s EBITDA. However, the multiple to be applied was in dispute. THG argued for a discounted multiple on the footing that the accounting errors called into question the accounts as a whole and further future issues could arise which would lower the value of the business to the buyer. A reduced multiple applicable to the warranty false valuation would increase the damages payable. The Court found that a discounted multiple would produce an unrealistic valuation of THG’s loss. It instead applied the original transaction multiple of EBITDA.

Defendants’ counterclaim

Valuation of consideration shares


The Trust had acquired a minority shareholding in THG the value of which was dependent on the same principles as applied to the value of the Cend shares at issue in THG’s claim. One issue for determination was the extent to which the Court should take account of matters following the breach in assessing loss. The basic principle is that the loss is suffered and damage should be assessed at the date of breach.

THG contended that, as the company was doing well and the Trust still had its shares, it had suffered no loss. The Court concluded that no account should be taken of the improvement in the state of the company following breach. The Court found that the present case was distinguishable from The Golden Victory (Golden Strait Corp v Nippon Yusen Kubishika Kaisha [2007]) in which it was held that where value depends on the outcome of a future contingency, the known outcome of that contingency may sometimes be taken into account, but only where ‘necessary to give effect to the overriding compensatory principle’.

Fraud

It was THG’s financial controller who was central to the fraud which had affected the company’s accounts. THG argued that this was not an act of THG. The attribution of acts and omissions by natural persons to a company is a matter of construction in each case. The Court found that THG’s financial controller had been heavily involved in the transaction. He had provided the financial information on THG which was essential to the deal proceeding. Other members of the finance department were also involved in the fraud. In these circumstances, the Court concluded that the fraud (the admitted breach of warranty) could be attributed to the company. As a result, the £7.24m contractual cap on liability did not apply.

IN CONCLUSION

This decision underlines the fact that normal principles of construction apply to these types of notice clauses in a share purchase agreement. The clause will be given its natural and ordinary meaning. While practitioners involved in breach of warranty and other post-M&A disputes will need to consider each provision on its terms, the wording of the clause in the present case is commonly used in share purchase agreements. So this decision provides useful guidance to practitioners. The judge’s comment that ‘nothing much’ was required for the purposes of providing information on the nature of the claims under the notice clause, despite the clause specifying that ‘reasonable detail’ was required, is important.

The case does demonstrate the scope for sellers to argue that a buyer’s claim should fail for want of complying with a notice clause. So while buyers commonly agree to a time limit on notifying claims, the particular provision should be carefully drafted to avoid any ambiguity as to when time starts to run, and also as to what exactly is required to be notified to found a claim. In the adrenalin rush of securing a commercial deal, it is easy to pay less attention to what appear to be boilerplate clauses at the end of the share purchase agreement.