Claims in relation to share purchase agreements — how to deal with warranty claims in their early stages
Practical advice on dealing with warranty claims.
In this second article of our series on disputes arising in the context of share purchase agreements (SPAs), we look at the early stages of a claim. As might be expected, the context is the sale of a business — a natural part of the lifecycle of most companies.
Whether a business has succeeded and it is time for the owners to cash out, part of the succession process or a business being sold out of a group because it doesn’t fit the rest of the business or might function better in someone else’s group, sales of companies and businesses are an everyday feature of the commercial world.
It is therefore unsurprising that virtually all business owners are likely to find themselves, sooner or later, either purchasing or selling a business. However, a number of problems occur, time and time again, when it becomes necessary to make or defend a claim because the business that has been sold is not all that it was cracked up to be.
Any purchaser will want to know that it has got value for money. Nothing is more unpleasant than discovering that the business you purchased is not worth the price that you paid. That might be for any number of reasons, including:
- The accounts of the business failing to disclose its true commercial circumstances.
- The business being subject to claims by one or more individuals or businesses, with those claims having the ability to devalue the business as a whole. This might include outstanding tax or other claims.
- The business simply not functioning as promised or otherwise being less profitable than anticipated for some other reason.
In this article, we look at some of the important practical points that arise, at the outset, when an unsatisfied purchaser needs to start the process of making a claim for breach of warranty.
The clock is ticking
Inevitably, it seems, in order to get the deal done it becomes necessary to ramp up the pressure on either the purchaser or the seller (or more often both) so that negotiations, due diligence and the completion of contractual documents all get shoe-horned into a relatively short period. As a result of this, it is not uncommon for potential grounds of claim simply to become lost or overlooked in negotiations. Sometimes insufficient attention is given to what is considered, at the time, to be a minor issue.
Whatever the actual oversight is, the problem lies dormant, waiting to be the subject matter of a claim — most likely by the purchaser after the dust has settled and once the new business is being run by its new owner.
An issue here is often what has been (or should have been) disclosed. The threshold for the disclosure of matters which might impact on the willingness of the parties to enter into the deal or the price which the purchaser will be prepared to pay, is usually set by the parties. Canny vendors can seek to lower the strength of any obligation imposed on them by an SPA to disclose matters which might lead to a potential warranty claim — perhaps applying a standard different to the usual “full and fair” basis. In the case of Infiniteland Limited v Artisan Contracting Limited  EWCA Civ 758 the vendor did just that, seeking to reduce its obligation merely to disclosing matters factually and, in that instance, it was down to the purchaser to discern the potential for a claim based only on the facts as presented. Bottom line: there can be opportunities for potential claims to slip through the net of due diligence and it’s also possible that the terms of the SPA may result in your having “deemed knowledge”, if not actual knowledge, of potential problems. This will be dealt with more fully in other articles in this series.
Typically, claims which come to light after the sale of the business are made as "warranty claims" — being based on warranties provided by the vendor as to the good standing or financial status of the business that is being bought or sold.
If the warranties given in an SPA turn out to be inaccurate, they give grounds to sue the provider of the warranty for breach of contract — for the measure of damages of the loss to the recipient arising out of their inaccuracy.
Most contracts that seek to limit the scope of post-sale claims have a number of standard exclusion provisions. These can make it difficult for a discontented purchaser to make a claim. As a vendor, it is always worth attempting to draft those clauses as widely as possible. The issues of quantifying a claim and whether it is “material”, so that it meets any contractual threshold for the bringing of claims, can also be matters with which a potential claimant needs to grapple. This will also be covered in subsequent articles in this series.
This is one of the most common areas where difficulties arise for purchasers who wish to make claims; when it emerges that the agreement they have signed provides for a short "limitation period" within which claims must be commenced.
Under English law, a claim for breach of contract (i.e. the business you are purchasing not being as described) must, in most cases, be brought within a six-year period. Sometimes, where an agreement is signed as a deed (a special form of contract) that period is extended to 12 years. However, it is quite possible for the parties to agree to a shorter contractual limitation period — and that is what is virtually always done.
Typically, the contractual limitation period for making claims is from 18 months to two years. That’s the period that the potential claimant has to make its claim. If that period is missed you are simply out of time to make your claim and that is likely to be the end of the road.
In relation to tax claims, the period usually runs to six or seven years, reflecting the fact that purchasers do not wish to find themselves liable for the tax that arose prior to the purchase (and which perhaps only came to their attention on subsequent notification by the Revenue) and prevented from claiming that back from the vendor. Another issue is the time limits for bringing claims after notification has been made — a potential claimant will find, in most cases, that the giving of notifications starts a second clock running. They may only have a further six or 12 months thereafter to issue a claim. Failure to do so acts as a bar to future proceedings.
Notification of claims
So, as can be seen, hand in hand with limitation periods go notification provisions. These are the terms of the contract which set out how the fact that a claim is going to be made should be notified to the other party.
Typically, the mechanism for giving a contractual notice is set out in the contract. An agreement's notification clause can provide for:
- Where the notice is to be given — for instance at a company's registered office or at the offices of a party's solicitors;
- How the notice is to be communicated — by hand, by fax, by e-mail or a combination of these and perhaps other methods; and
- Whether any specific information is to be included in the notice.
Getting any of these wrong could result in an invalid notice being served. If time is short, getting the notice right first time may be critical to the preservation of the claim.
It is not unusual for notice of a potential claim to be served by a company's secretary or responsible officer because of time pressure. However, a knee-jerk reaction to serve a notice which subsequently, it emerges, was inadequate because it did not comply with the contractual requirements, may mean that all hope of making a claim is lost. This will certainly be true if there is no time to give a further notice. This is to be avoided at all costs.
Practical points to remember
- Ensure that the company has someone who is specifically responsible for fielding or giving notice of claims that are to be made in relation to the business that has been sold or purchased.
- Request from your lawyers a schedule of limitation periods which apply to all relevant agreements. This work can often be undertaken during the course of the transaction itself, failing which any solicitor should be happy to review the provisions of the SPA and provide a brief note on what is required — if he or she is only asked to do so. Although this may seem like unnecessary work, the benefits of being informed about the mechanisms for making and resisting claims etc. are self-apparent when a potential claim arises.
Serving a defective notice (and thereby subsequently losing the opportunity to bring a legal claim) is far from uncommon.
In one case the purchaser acquired a number of companies from the vendor. The notice provisions set out clearly that, if notice of a potential claim was to be made, this was required to be given within a specific time and that reasonable detail of the potential claim was to be given.
When the purchaser became aware of potential claims for breach of warranty in the SPA, it instructed its solicitors to write to the vendor, putting it on notice of the claims. This was done — but only at a high level and without detail of the claim being provided. The vendor’s solicitors objected, stating that the detail provided was inadequate.
After a further round of solicitors’ correspondence, some further detail on the potential claims was provided — but the vendor still disputed that a reasonable level of detail had been provided. Matters proceeded to court. The outcome: the court struck out the claim on the basis that the notice provisions of the SPA had not been complied with. Had reasonable detail of the claims been given at an early stage, that outcome could have been quite different.
In other cases, the time limits for notifying claims have been strictly adhered to by the court. The consequence? Notices provided after the period provided for have been held to be entirely ineffective. Notice periods of 18 months, in one case, were deemed completely reasonable.
What’s the position where, say, a vendor deliberately misstates the position — concealing grounds for a potential claim or providing a warranty in the knowledge that future claims may not come to light until after the limitation period provided for in the relevant notification provision has passed?
This, of course, is a position that might be covered off under the relevant SPA. There may, for instance, be an express provision that each party has disclosed all matters which might reasonably be considered relevant — in itself a warranty.
Even if there is no such provision, deliberate and dishonest attempts to conceal matters which are certain or likely to give rise to a claim or claims can, if they are fraudulent, prevent the operation of terms of the SPA which might otherwise limit the ability of a purchaser to make a claim for breach of warranty. So, by way of an example, a vendor who was aware of, say, an environmental issue which was unlikely to come to light but concealed this, believing that this would not become apparent until after the time limit for bringing a claim had passed, could not rely on the relevant time limit. Of course, that’s a long way from the usual situation, which is that claims are not always foreseen. If a notice clause is being used to protect the vendor from carrying liability into the future, after a set time, that is fair and reasonable and can (and will) be enforced.
The general position is that fraud acts to unpick any agreement which (were it not for the fraud) would otherwise limit the ability of a purchaser to make a claim. So those deliberately seeking to mislead a purchaser may find that even the finest drafting of notice provisions avails them not at all.
Warranty claim checklist
Those in business know that few things in life go off without a hitch. It’s axiomatic that most business sales will leave at least one of the parties with an unexpected problem that might give rise to a claim. Whether it’s the tail end of a claim for tax, an unexpected liability for pollution on a redevelopment, public liability issues or something else entirely unforeseen, bear in mind the following if you are the purchaser or seller of a business:
- Is there potential for a claim?
- Where are the relevant documents and agreements which all relate to the claim or govern how it should be made?
- What is the deadline for making a claim? Bear in mind that limitation periods for tax claims are sometimes longer than six years — but not always.
- Should insurers be notified? If notification is not made to insurers, as soon as possible, this may void your insurance cover if applicable. Although it’s outside the scope of this article, consider in particular the scope for claims under Warranty and Indemnity (W&I) insurance — and, whether you are a buyer or seller, follow the notification requirements to the letter to avoid cover being lost.
- Should notification be made to the seller of the business?
- If so, to whom does the agreement say that it should be made?
- Where is the notification to be delivered?
- How is it to be sent?
- What proof can be obtained that notice has been given? This proof should always be carefully preserved.
- After notification of a claim, what further action should be taken? Does the agreement provide that any other parties are to be consulted regarding the claim? Is there a deadline for subsequently instituting formal proceedings?
This is one area where, as a firm (and particularly as litigators), we see basic mistakes, easily capable of prevention, occurring and resulting in significant losses to those involved. Perhaps the one overarching principle to take away is this — set a date, after selling or acquiring a business, to check the notification provisions and consider whether claims have arisen or are now likely to arise; consider this, if you like, a warranty claims “clinic”. If the likelihood of such claims has increased, take advice and act, before the opportunity to do so is lost.
For more information on share purchase agreements, contact our mergers and acquisitions lawyers.