The importance of a valid notice of warranty claim – recent guidance from the courts
We review two recent cases where the courts provided guidance on the way warranty claims need to be framed to avoid difficulties.
Typically, when a business is purchased there are key provisions in the acquisition agreement or share purchase agreement (SPA) specifying how notice of a warranty claim should be given and the level of detail which it should contain.
In this article, Andrew Cromby and Benjamin Turner consider two recent cases in which the courts provided guidance regarding the way in which warranty claims need to be framed in order to prevent difficulties for both the purchaser and vendor of a business.
As explained in our article on dealing with warranty claims in their early stages, warranties are contractually binding statements of fact as to the condition of the business, given to the purchaser by the vendor. The purchaser is entitled to rely on those warranties – if they are inaccurate, this gives grounds for a claim against the vendor for the damages that flow from that inaccuracy.
Recent case law
Recent Court of Appeal cases have demonstrated that there can be very significant legal and financial consequences arising from a failure to provide a valid notice of claim in relation to warranties given in an SPA. Get the notification process wrong and you will rue the day that you despatched your notices without having due regard to the relevant notice provisions. In these cases, the courts have applied a strict and objective interpretation of the construction of the notice provisions in a SPA. On the one hand this is useful in promoting certainty for vendors giving warranties, but that approach can also leave purchasers vulnerable to being barred from making a claim where inadequate care and attention has been given to preparing and serving the form of notice.
What happened in these cases?
In the first case, Stobart Group Ltd & Anor v William Stobart & Anor , the purchaser served what they considered to be a valid notice of claim on the vendor. This was a claim in respect of alleged breaches under the tax warranties in the SPA. The outcome of the £3.8 million claim for breach of warranty hinged on the validity of the notice of claims which had been served by the purchaser.
The acquisition agreement in this case contained two separate and distinct “notice procedures”:
- The first was intended to be a notification mechanism for the vendors to be told by the purchaser of any claim, notice or demand which "the purchaser received from a tax authority” (“Procedure 1”); and
- The second was one in which formal notice was to be given by the purchaser to the vendor in respect of a claim that the purchaser would bring against the vendors (“Procedure 2”).
Upon learning that it had an unexpected liability to tax, the purchaser served a notice of claim on the vendor. The question was, under which notice procedure did it fall? If the purchaser wanted to be able to bring a claim against the vendor in respect of the tax, a “Procedure 2” notice was called for – which should have been drafted to provide the vendor with information regarding the claim and (crucially) requiring the vendors to pay the tax liability in accordance with certain provisions in the acquisition agreement. It was therefore critical for the purchaser in this case that the court considered that the notice was given under “Procedure 2”.
The vendors argued that the notice was not a valid “Procedure 2” notice and therefore claimed to be exempt from discharging the tax liability. The notice was served just days before the seven-year time limit on the tax warranties expired, thereby realistically eliminating any second attempt by the purchaser to serve a further (compliant) notice - which otherwise might have been an option. The vendors had (perhaps cannily) waited for the time limit for serving a valid notice to pass before raising any concern that the notice was invalid. As a result, the court’s determination as regards which procedure the notice fell under was effectively going to decide whether or not the claim could be brought or was time-barred.
The court’s approach
The Court of Appeal decided that the notice was not a valid “Procedure 2” notice, which meant that the £3.8 million tax liability could not be claimed under the tax warranties. The purchaser was out of time to serve any additional notice.
The court made it clear that it was required to analyse the meaning of the words used in the notice objectively and, similarly, to take an objective view of the context surrounding the notice.
Accordingly, the court noted that:
- the notice made no reference to a tax claim, a claim under the relevant provision in the SPA or indeed any claim being made against the vendors;
- the notice made reference to a contingency, citing a ‘potential liability’ and a ‘potential claim’, as opposed to referencing an actual claim; and
- the notice made reference to a different provision of the acquisition agreement (the provisions regarding Procedure 1), seeking the vendors’ confirmation regarding conduct of further discussions with HMRC of this ‘potential’ tax claim.
The purchaser advanced an argument that the vendors should have understood that the notice amounted to a “Procedure 2” notice. They drew on the fact that they had, a month prior, sent a letter to the vendors advising them of a potential HMRC liability. In this letter, they referred to the provisions enabling them to send a “Procedure 2” notice, whilst also requesting an extension on the seven-year limitation period in consideration of ongoing discussions with HMRC. The purchaser contended that the letter would have put the vendors on notice that they could ‘potentially’ expect a “Procedure 2” notice before the end of the limitation period. The court rejected the purchaser’s argument, citing that there was still time for them to have sent a valid notice before the expiration of the limitation period, therefore making it unclear that no further notice would be received before the end of this period.
In the absence of a common understanding between the parties regarding the notice, which was drafted unilaterally, the express wording of the SPA took on greater importance – after all, the parties had jointly drafted and agreed the SPA. So the ‘subjective’ intention of the party sending the notice was not relevant to questions of how an inadequate notice “ought” to be understood by the recipient. In other words, when drafting your notices of a warranty claim, be clear and follow the agreement to its letter.
The second, case, decided just a year before, is Triumph Controls UK Ltd v Primus International Holding Co . It demonstrates that the way that warranty claim provisions are interpreted by the courts can be a headache for the vendor as well as the purchaser.
In this case, the High Court considered several warranty claims brought by the purchaser under an acquisition agreement and, in particular, whether the purchaser had served proper notice of the warranty claims that it wished to make against the vendor.
Under the terms of the agreement, the vendor was only liable for warranty claims if the purchaser:
"(1) provided notice in writing of the claim, summarising the nature of the claim as far as it is known;
(2) specified the amount claimed; and
3) submitted the claim within 18 months of the completion date”.
Here, the vendor argued that the purchaser had failed to summarise the nature of the claims correctly, because the purchaser had described some matters in the notice but also included additional and/or different complaints when legal proceedings were eventually brought against the vendor. The vendor argued that because the additional matters were not expressly mentioned in the notice, they could not constitute part of the claim. Notification had not been given in respect of these matters, so they should be excluded from the claims that the vendor had to face. That, they said, was what had been agreed in the SPA.
The court rejected this argument, stating that the vendor was clearly aware of the substance of the purchaser’s claims. It was not necessary for every relevant warranty to be listed when it was clear what the purchaser’s complaint extended to, overall. The court considered that the language used provided sufficient detail and was wide enough to encompass other types of claims that might evolve in the future. Notably, the court found the following:
- a 'summary' of a claim did not mean full details or particulars of claim (as set out in court proceedings);
- the purchaser must give formal notice of the basis of claim and it must be unambiguous and sufficient for the vendor to investigate, respond to and make financial provisions for; but that
- if a notice does not refer to the claim at all, it will be excluded by the court.
This goes to show that any ambiguity in the preparation of warranty claims relating to SPAs or acquisitions can come back to haunt vendors as well as purchasers – and emphasizes the need for precision in the drafting of any SPA. The 'objective approach' adopted by the court led to the vendor’s argument failing, due in large part to the use of the word 'summary' in the acquisition agreement. Implicitly that meant there could be more included within the claim than the matters expressly referred to in any notice. Better wording, from the vendor’s perspective, would have been “details of all claims to be pursued”, as opposed to the far less specific "summary".
What can we take away from these cases?
The ability to make a claim on the basis of a breach of warranty is a fundamental feature of acquisitions and drafting a notice of claim which complies with the SPA is hugely important where a purchaser wishes to assert their right to make a claim. Losing out on that right because of sloppy drafting and/or service of the notice is catastrophic and should, in most cases, be entirely avoidable.
These cases underline the court’s emphasis on how notice of a claim provides commercial certainty for both parties to a SPA and the corresponding need to adopt strict compliance when following these provisions in order to avoid invalidating any notice or claim.
This is important – because vendors, in particular, love to “win on a technicality” i.e. take advantage of a notice failing to comply with the precise requirements of a SPA. Purchasers need to be meticulous and comply exactly with requirements imposed on them. For example, if the SPA provides for a claim against the vendor for a tax liability and has a time limit (as in Stobart, above), make reference to the specific paragraph of the warranty and use language which is unambiguous and clearly identifies the exact nature of the claim. As a vendor receiving a notice, checking the notice against the SPA provisions which govern it, particularly if there is a time limit attached to the warranty it relates to, could also be crucial.
- DON’T: send correspondence which is too vague or indicates that you may be thinking about making a warranty claim, mistakenly believing that this suffices as a valid notice.
- DO: ensure you thoroughly read the terms of your agreement around warranties and, in particular, how to serve any notice.
- DO: seek legal advice if you are unsure in any way. As outlined above, the devil is in the detail and that can make or break your ability to make a claim.
- DO: regularly review the applicable time-limits and diarise these (in advance) so that you do not become time-barred.
If this article raises any queries for you, please contact Benjamin Turner, Paralegal at email@example.com or Andrew Cromby (see details below).