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The danger of non-disclosure in acquisitions

The importance of sellers of shares or assets ensuring they adequately disclose against the warranties they give in the acquisition agreement has been…

The importance of sellers of shares or assets ensuring they adequately disclose against the warranties they give in the acquisition agreement has been highlighted in the recent High Court decision of Liberty Partnership Limited v Tancred [2018]. In that case, the sellers' failure to disclose allowed the buyer to avoid the limitation period for bringing claims set out in the agreement and permitted the buyer to bring certain claims for breach of warranty 11 years after completion.

Specifically, the High Court considered, on a trial of preliminary issues, whether the buyer should be permitted to proceed to trial in respect of certain warranty claims that the buyer alleged arose or were delayed by the wilful concealment of the sellers.

The sellers sold their shares in a financial services company to the buyer pursuant to the terms of an acquisition agreement in 2007. As is usual in acquisition agreements, the sellers provided various warranties to the buyer as to the condition of the target company’s business. The benefit of warranties from a buyer’s perspective is to give the buyer a claim for breach of warranty if any warranty given by a seller can be proved to have been untrue, and depending on the warranty in question that has been breached, and the value of the target company, compensation to the buyer for such breach.

A seller will (or should) disclose against any warranties that are untrue by means of a disclosure letter provided to the buyer at completion. In the present case, the standard of disclosure required of the sellers was that a disclosure against the relevant warranty needed to be fair and accurate with sufficient details to identify the nature and scope of the matter disclosed. This is a typical standard of disclosure appearing in acquisition agreements. The buyer alleged the sellers failed to properly disclose against certain warranties in contravention of this standard.

One major issue for the buyer was the limitation period for notified warranty claims was 18 months from the date of completion in 2007. In addition, warranty claims had to have had legal proceedings commenced in respect of them within 6 months of the expiry of the 18 month period. The buyer had not notified the sellers of the warranty claims or commenced legal proceedings in accordance with these provisions and was now many years out of time for doing so. Significantly, however, the acquisition agreement contained a provision which circumvented the above 18 month limitation period. It provided that the restricted period did not apply to a warranty claim in the case of "… dishonesty, fraud or wilful concealment by the Sellers…". The buyer alleged that the sellers had wilfully concealed a number of matters. If the buyer could persuade the court that the sellers had engaged in wilful concealment of certain matters it could then proceed to trial on such claims.

Given that the meaning of wilful concealment might be considered to be unclear under English law, and determining whether information had been wilfully concealed was in fact the court’s primary function in this case, it is perhaps a little surprising the court did not consider the meaning of wilful concealment itself. Given the lack of examination by the court it appears the court gave those words their natural and ordinary meaning. To examine these words a little further, the case of Williams v Fanshaw Porter & Hazelhurst [2004] has considered the meaning of "deliberate concealment" in the context in which those words appear in section 32 of the Limitation Act 1980. Arguably, the words "wilful" and "deliberate" have substantially the same meaning for these purposes. The court said "… for the concealment to be deliberate, the defendant must have considered whether to inform the claimant of the fact and decided not to… the fact which he decides not to disclose either must be one which it was his duty to disclose, or must at least be one which he would ordinarily have disclosed… but … he consciously decided to … keep quiet about it".

If the buyer was able to persuade the court that the sellers had wilfully concealed certain information from it, doing so would have the effect of avoiding the 18-month contractual period for the period specified in the Limitation Act 1980. The normal period for bringing claims for breach of contract is 6 years (under section 5 of the Limitation Act 1980). However, the court concluded, after some detailed examination of case law, that the 12-year time limit for bringing claims as specified in section 8 of the Act applied as the acquisition agreement had been executed as a deed – the Act in that section refers to a "specialty" which means a sealed document and the court concluded that a deed was a specialty provided it had been executed in accordance with the Law of Property (Miscellaneous Provisions) Act 1989 even though in this case the acquisition agreement had not been sealed. This was an issue it said the courts do not appear to have previously considered.

Of the six allegations of wilful concealment alleged by the buyer the court permitted the buyer to proceed to trial in respect of three of them.

It can be the case in acquisition agreements that exceptions for matters such as wilful concealment and fraud etc are limited not only to time periods for notifying or commencing claims as they did in the present case, but to potentially all provisions designed to protect the sellers where a warranty claim is made by the buyer. These protections usually cover issues such as setting the individual and aggregate financial threshold for warranty claims before they can be brought and most importantly the financial cap on a seller’s liability for breach of warranty (and perhaps other) claims made against it. Further protections include the buyer being required to claim against insurance policies or third parties for warranty claims before pursuing the seller and the seller not being liable for acts of the buyer that result in a warranty being breached. These protections tend to be heavily negotiated by the parties as they are ultimately designed to require the buyer to overcome a number of hurdles so that the seller retains as much of the purchase price as possible. Sellers should be aware that if the buyer insists that none of the seller protections apply in cases of fraud, wilful concealment etc the seller is going to be left heavily exposed and perhaps for an unlimited sum. Typically, a buyer will argue that the seller should not have the benefit of any protection mechanisms in the acquisition agreement if the seller has engaged in fraud, wilful concealment or similar acts.

The judgment in this case did not specify the reason for the acquisition agreement having been executed as a deed and so providing a benefit, to the buyer in this case, of the ability for it to bring a claim against the sellers some 11 years after the sale of shares to it was completed. There is usually no reason for an acquisition agreement to be executed as a deed unless it contains terms which to be valid and enforceable need to be executed as a deed, such as a guarantee for which consideration is not being paid or a power of attorney which, in this context, would typically relate to the grant of a power of attorney to the buyer so that it can vote on the shares being purchased until such shares are registered in the name of the buyer by the directors of the target company. However, this can also be achieved by entering into a separate document.

This case highlights the importance of a seller adequately disclosing against warranties that it is giving to the buyer. The standard of disclosure that a seller is required to meet in its specific disclosures against the warranties is normally defined in the acquisition agreement. If a seller fails to meet that standard of disclosure it is at risk of a warranty claim. If, however, the seller fails to disclose certain matters it is not only the terms of the acquisition agreement that will apply.

Whilst acquisition agreements will typically include a provision that creates an exception to limitations or restrictions relating to warranties, as it did in this case in respect of wilful concealment, the seller is also at risk of committing a criminal offence and may also have potential liability for civil wrongs. From a seller’s perspective, it is generally better to disclose properly against the warranties than not. Furthermore, from a seller’s perspective, it is preferable for the acquisition agreement to not be executed as a deed because, as this case has highlighted, the seller’s exposure to certain claims is twice as long for a deed than it is for a simple contract.

For help and support on getting a merger or acquisition right, contact our mergers and acquisitions lawyers.

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