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Share purchases: vendor protection on warranty claims and basis of interpretation

A recent decision has again highlighted the importance of careful drafting of clauses in sale and purchase agreements which deal with warranty…

A recent decision from the Court of Appeal involving North West company, The Hut Group, has again highlighted the importance of careful drafting of clauses in sale and purchase agreements which deal with warranty claims and the related vendor protection provisions.

Background

In 2011 The Hut Group (The Hut) acquired Myprotein.com, the UK’s leading online retailer at the time in the sports nutrition market (Target) from Mr. Oliver Cookson and others (Vendors).

The sale and purchase agreement (SPA) contained usual warranties from the Vendors about the Target and its business including usual financial warranties relating to the Target's management accounts. The SPA also contained standard vendor protection provisions limiting the liability of the Vendors in relation to those warranties (Vendor Protection Provisions). These included a clause which said that the Vendors would not be liable for a warranty claim unless The Hut served notice of the warranty claim "... as soon as reasonably practicable and in any event within 20 Business Days after becoming aware of the matter".

The Hut brought a claim for breach of the management accounts warranties, alleging that the warranties did not give a true and fair view of the Target's financial position (Warranty Claim).

The Vendors defended the Warranty Claim, claiming that The Hut was out of time because the notice of Warranty Claim was not given within the time period required by the Vendor Protection Provisions. The Vendors argued that the relevant clause required that the time period for notifying a Warranty Claim ran from when The Hut became aware of the factual grounds for a Warranty Claim, not when it became aware that those grounds might constitute an actionable Warranty Claim.

High Court

The High Court’s decision was that the Warranty Claim was not out of time. The wording "becoming aware of the matter" should be interpreted to mean "becoming aware of the Warranty Claim". The High Court differentiated between awareness of facts giving rise to the Warranty Claim and awareness that there might be a claim on the one hand, and awareness of "a proper basis" for the Warranty Claim, on the other. It concluded that The Hut could only be said to be "aware of the matter" in accordance with the SPA on receipt of advice from its accountants that there was a Warranty Claim based on analysed information - which meant that notice of the Warranty Claim had been served in time.

The High Court refused to apply the ‘contra proferentem’ rule (where there is doubt about the meaning of a contractual provision, the words will be construed against the person who puts them forward), because the SPA included warranties from both parties with equivalent protections benefiting both The Hut and the Vendors.

Court of Appeal

The Vendors appealed. In the context of the warranty claim, the Court of Appeal was asked to determine whether the phrase "becoming aware of the matter" meant:

a)     aware of the facts giving rise to the claim (even if unaware that those facts did give rise to a claim);
b)    aware that there might be a claim; or
c)     aware that there was a proper basis for the claim.

The Court of Appeal unanimously dismissed the Vendors’ appeal, and agreed that the Warranty Claim could be brought by The Hut. Ambiguities in the Vendor Protection Provisions should be resolved by adopting the narrowest of available interpretations, and that construction (c) (aware of the proper basis for the claim) should be preferred.

The Court carefully considered the language used in the Vendor Protection Provisions, their purpose and what the parties were trying to achieve. They concluded there was no clear answer. The word “matter” used in the Vendor Protection Provisions did not clearly mean Warranty Claim, and could easily refer to some entitlement to bring a Warranty Claim or to some basis of fact, or mixed fact and law, from which the Warranty Claim would arise.

The Vendors asked the Court to apply construction (a) above. However, if this approach were adopted, the Vendor Protection Provisions could prevent a Warranty Claim simply because The Hut was unaware of the claim. This was not the intention behind the Vendor Protection Provisions, which were drafted to prevent The Hut from delaying in bringing a Warranty Claim that it had known about for some time. The Court said this would “make such a large inroad into The Hut’s entitlement to compensation for breach of warranty, for no sensible purpose, that it would have taken clearer words than the parties had chosen to use to achieve that result”.

The Court of Appeal rejected construction (b), which required notification when a Warranty Claim was merely suspected, as being too uncommercial.

The Court determined that it was better to interpret the Vendor Protection Provisions as requiring awareness of the Warranty Claim rather than awareness of the underlying facts. The Court of Appeal was considerably assisted by the perception that the ambiguities in the Vendor Protection Provisions could properly be resolved by having recourse to the narrowest of the available interpretations. They may have reached the same decision, but the High Court and the Court of Appeal took different approaches on the ‘contra proferentem’ rule:

  • the High Court said the rule should be disapplied, as the SPA included warranties and equivalent protections for both parties; whereas
  • the Court of Appeal said the ‘contra proferentem’ should not have been disapplied, preferring to apply the rule to both sets of protections in the SPA, to the extent relied upon and required.

The Court of Appeal was persuaded that a purposive interpretation of the Vendor Protection Provisionsnarrowly favoured construction (c), being the narrowest of the available interpretations of an ambiguous exclusion clause.

Comment

The provisions in sale and purchase agreements which deal with warranty claims, and the related vendor protection provisions, are critically important and always heavily negotiated. The headline consideration is irrelevant if the vendors stand to lose their sale proceeds for want of protection by the vendor protection provisions. Whilst the sale and purchase agreement is usually drafted by the buyer, the vendor protection provisions are almost always drafted by the solicitors for the vendors. Great care needs to be taken to ensure these clauses are drafted properly, without ambiguity, and that they adequately protect the vendors and their sale proceeds. If the provisions are unclear in any way, given the particular sensitivities around these clauses (buyers usually do not bring warranty claims lightly and vendors want to protect sale proceeds), this will lead to litigation.

For advisors, it is interesting to note the Court of Appeal’s views that:

  • the ‘contra proferentem’ rule, as it applies to resolve ambiguous clauses, may still serve to resolve an ambiguity which on the facts benefits the party against whom the clause is invoked, notwithstanding that the other party could potentially have benefited from the clause in different circumstances; and
  • ambiguity should be resolved by adopting the narrowest of several possible interpretations.

If you are interested in finding out more about this or any other corporate issue, please contact Sarah Walton, a partner in the corporate department, on 0161 214 0529 or email sarah.walton@weightmans.com.