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Litigating for Breach of Warranties in the Sale of Companies

By August 9, 2023June 26th, 2024No Comments

In any purchase of a company, the seller and the buyer often rely on certain assumptions in reaching a purchase price. In particular, the buyer will want to protect itself by holding back some of the purchase monies to allow for a certain ‘earn-out’ period to play out, usually 2-3 years, to ensure that the profits in the company can be repeated on a consistent basis. If this is not the case, at least the buyer has the comfort of being able to withhold the balance of the consideration which forms the basis of the ‘earn-out’ provisions.

However, if a purchaser acquires a company where it feels that the accounts were presented in an inaccurate fashion, then it may well seek to pursue the seller on foot of a breach of warranty.

Case law over the last number of years demonstrates that it is extremely important that warranties are both carefully drafted and that the sellers can stand over the warranties, and if not that they have fully disclosed against these warranties on foot of a disclosure letter.

It is also important that purchasers carry out sufficient due-diligence as a principle of ‘buyer beware’ applies to share-purchase transactions.

An interesting case in point of type of dispute that can arise was a 2019 case of 115 Cardamon Ltd v MacAlister and Another where the buyer sought to bring a claim for damages for the full purchase price under the SPA as a result of an alleged breach of warranty. The transaction went through very quickly, and the purchaser pursued the seller on foot of a warranty as to the truth, fairness, accuracy and proper preparation of the company’s audit accounts. The sellers further warranted that the management accounts ‘fairly represented the assets and liabilities and profits and losses of the target’ and that the accounts were not affected by any unusual or non-recurring items or any other factors that would make the accounts misleading.

The defendant sought to argue that the claim had arisen by reason of the fact that the buyer had adopted a different post-completion methodology for assessing the value of the liabilities, but this argument was dismissed by the court and the seller was held liable for the full purchase price on foot of the warranty claim by reason of the fact that the court held that the warranties were not accurate in a substantial manner and indeed it would appear that the target company was effectively insolvent.

One other area where sellers have to be very important and careful about providing warranties is in relation to future performance. In the case of Triumph Controls UK Ltd and Others v Primus International Holding Company and Others, the sellers had agreed to provide a warranty that ‘as far as the sellers are aware, the forward-looking projections relating to the companies have been honestly and carefully prepared’.

The sellers, on foot of a warranty claim by the purchasers, argued that they had not provided a warranty as to the accuracy of the projections, and that they had based their projections on due and careful enquiries.

However, the Court disagreed and concluded that the projection provided had failed to take into account key operational and financial assumptions, and that if these had been taken into account, the sale would have concluded at a lower purchase price.

In assessing damages, the Court operated a discounted cash flow approach to revaluing the company in order to assess the damages to which the purchaser was entitled.

When bringing a claim it is important to comply with the terms of the share purchase agreement and to try an create as much certainty as possible. A case of Towergate Financial (group) Ltd and Others v Hopkinson and Others was proof of the dangers of a purchaser delaying in bringing a claim where the terminology used for the purposes of bringing a claim was ‘as soon as possible’ after determining that with a breach. The Court held that the claim had not been brough as soon as possible, and was denied.

In another case of Stobart Group Ltd and Stobart Rail Ltd v Stobart and Tinkle, the Court rejected a claim by reason of the fact that the buyer had only notified the seller of a possible claim and not an actual claim.

As such, both buyers and sellers need to be aware of the following guidelines:

  1. From a seller’s perspective, be very careful of making any warranties in relation to the future financial performance of the company.
  2. When preparing clauses in relation to the notification of claims and the time frame within which claims should be brought, buyers must be very careful that these are clear and reasonable.
  3. The buyer should ensure that it carries out exhaustive due diligence before completing the purchase.
  4. Sellers should be very conscious of providing warranties in relation to the accounts/management accounts and should make sure that they can stand over them.

For further information on any matter relating to sale or purchase of companies or any business, please do not hesitate to contact Brendan Dillon or Lorna McArdle on 012960666.