Post transaction disputes: bringing warranty claims – key considerations
03 February 2023
The current economic climate may mean that recent purchasers of companies are looking to achieve an after-the-event price reduction, especially where the value of the company they have purchased may have fallen. One way of doing this may be to make a claim under the warranties in the share sale and purchase agreement (“SPA”).
What is a warranty?
A warranty is an assurance or promise given in a contract by one party to another. In the context of an SPA, the buyer will typically seek various warranties from the seller regarding the company that it is purchasing, for example:
“The Accounts show a true and fair view of state of affairs of the Company as at the Accounts Date”
“The plant and machinery is in reasonable repair and condition”.
Breach of a warranty may give rise to a claim in damages (see further below “What is the value of the claim?”).
Has a warranty been breached?
A buyer will first need to consider if any warranties have been breached. This may require some factual investigation and/or input from a suitably qualified expert (often an accountant).
- If the seller warranted that they were not aware of a particular fact or facts (e.g. they were not aware of any claim being threatened against the company, or a customer indicating an intention to cease trading with the company), the buyer is likely to need to carry out some investigations of the company’s emails and other documentation to see if there was a breach.
- If the buyer considers that there has been a breach of a warranty relating to the accounts, they are likely to benefit from the input of someone with expertise in accountancy.
Did the seller make a relevant disclosure against the warranty, or did the buyer otherwise have relevant knowledge?
SPAs typically provide that the buyer shall not be entitled to claim that a warranty has been breached if the matter, fact or circumstance giving rise to that breach of warranty has been “disclosed”. Typically, matters are “disclosed” in a disclosure letter given with the SPA.
It is also standard practice for a buyer to be barred from making a breach of warranty claim if the buyer had (actual) knowledge at the time of entering into the SPA of the facts or circumstances giving rise to the claim it is now seeking to make.
The buyer should therefore consider whether the seller made a (sufficient) disclosure against the relevant warranty, or if it could be said that the buyer had relevant knowledge of the facts or circumstances giving rise to the claim. If so, their claim is unlikely to get off the ground.
What is the value of the claim?
The value of the potential claim is likely to be relevant to the buyer’s decision as to whether or not to pursue the claim. It may also be relevant as to whether or not any minimum or maximum thresholds on warranty claims apply, and an indication of the value of the claim may be required as part of notice requirements under the SPA. It is often advisable to seek expert accountancy input to assist with valuation.
Unlike an indemnity claim, the remedy for a breach of warranty is damages. In the context of a share sale, damages for breach of warranty are calculated by comparing the difference in value between:
- (a) the value of the shares with the warranty being true (which is usually taken to be the consideration in fact paid for the shares, although a different figure may be used if the purchase price represented a particularly “good” or “bad” deal); and
- (b) the value of the shares given the true position.
The quantum of any damages claim will therefore be dictated by the impact of the breach of warranty on the market value of the shares. Therefore, a buyer should not expect pound-for-pound compensation for the loss it considers it has suffered. For example, if, in breach of warranty, a piece of machinery turns out not to be in reasonable repair and so the buyer has to buy a replacement, the buyer’s claim is not for the cost of replacing the machinery. Instead, the buyer is entitled to the difference between (a) the value of the shares in the company with that piece of machinery in reasonable repair, and (b) the value of the shares in the company with that piece of machinery not being in reasonable repair; which may be a very different figure.
Are there any limitations on the seller’s (or sellers’) liability?
SPAs often include limitations on the value of the claims that can be made, or the seller’s (or sellers’) liability in respect of any such claims, which are likely to have been subject to negotiation prior to signing the SPA. These limitations can take different forms:
- “de minimis” limits can operate to exclude low value claims by providing a minimum limit for individual claims;
- “threshold” or “basket” limits can provide a minimum limit for aggregate claims; and
- overall caps can provide an overall maximum cap on the liability of the seller(s) for warranty claims.
Where there are multiple sellers, there may also be limitations as to the amount that each individual seller is liable for. Typically, individual sellers will wish to limit their liability for any breach of warranty proportionately in line with the proportion of the overall purchase price that they received.
Is it worth suing the seller(s)?
Before suing any party, it is always worth establishing that the prospective defendant(s) would actually be able to satisfy any judgment awarded against them. However, even if the seller(s) are not good for the money it may be that a warranty claim is still worth pursuing as:
- it may be possible to set off any warranty claim against deferred consideration otherwise owed to the seller(s);
- the seller(s) may have warranty and indemnity insurance; and/or
- there may be a bank guarantee, escrow account or retention monies that can be claimed against.
What needs to be done to make a warranty claim?
Well drafted SPAs typically include “gateway” provisions for bringing a warranty claim. These usually require the buyer to provide notice of claims (often requiring some detail of the claim and an indication of its value), within a particular time period, and by a particular method. Failure to comply with these provisions can shut out an otherwise valid claim, so it is very important that a buyer reviews the SPA to determine what, if any, notification requirements must be complied with. Sometimes the notification provision might be onerous and expert help could be needed to prepare a compliant notice. Again, allowance should be made for that work so that the deadline can be met.
For a more detailed consideration of notice requirements please see SPA Warranty claims getting the notice right and our associated flowchart summarising the relevant issues Notification Issues for Warranty Claims a flowchart.
Is there a time limit to bring a claim?
As well as there being a time limit for a buyer to notify the seller(s) of a claim, the SPA may also include a time limit for issuing proceedings at court. Whilst the default position is that a party has six years in which to issue proceedings in respect of a claim for breach of contract (and twelve years if the contract is executed as a deed), SPAs will often provide for a shorter period in respect of breach of warranty claims (often one or two years for “regular” warranty claims, but longer for tax warranty claims). Buyers should obviously check the SPA for any such time limits and ensure that deadlines are not missed.
Tips for buyers (and sellers)
Buyers are advised to seek specialist advice as soon as they become aware of any circumstances that may give rise to a warranty claim, to assist them in establishing whether or not they have a valid claim that is worth pursuing and then to ensure that the relevant notice requirements are complied with so as to not lose that claim.
As soon as sellers receive notice of a claim they should consider carefully whether notice requirements have been met, and take advice on their potential liability. Where a notice is non-compliant, a seller is often best advised to only raise issues after the expiry of the relevant notification deadline has passed. This will make it impossible for the buyer to rectify any defects in the notice. If there is a time limit on issuing proceedings, sellers who recognise that there may be a valid claim against them may wish to engage swiftly with buyers to attempt to reach a negotiated solution before the buyer is forced to issue proceedings.
We have created an initiative called “LS Unlock” to help businesses access legal advice during the uncertain times ahead. LS Unlock comprises a free initial assessment of significant commercial and corporate claims together with a menu of alternative fee arrangements which can reduce and, in certain cases, eliminate the upfront cost of pursuing a claim. This initiative has been designed specifically to assist clients in this uncertain economic climate and is part of our commitment to working with clients to help them survive its effects.
Also in our economic downturn series…
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