Breach of warranty: What goes through a litigator’s mind?
08 June 2021
Back in March, I interviewed two of our Litigation partners on the topic of M&A disputes as part of our Corporate Academy programme for clients. They shared some thoughts that automatically go through their mind when looking to bring or defend a breach of warranty claim: What did the seller disclose? What did the buyer know about? Were the notice provisions in the SPA adhered to? Could a misrepresentation claim be used to circumvent limitations in the SPA?
Well it seems it’s not just A&O’s litigators that think that way: all of these points were argued in the recent case of MDW Holdings v Norvill. The buyer’s (successful) allegation was that the waste management company it acquired had systematically breached environmental laws and unlawfully avoided the costs of environmental compliance, increasing its profits to levels that wouldn’t have been achieved had it acted lawfully – with the result that the buyer paid more for its shares than they were worth. An example: discharging cess waste directly into the public sewer via an inspection chamber known as “the magic hole”.
So how did the arguments play out, and what are the takeaways when advising on M&A transactions?
In what is a pretty standard formulation, the warranties in the SPA were subject to matters which had been “fairly disclosed (with sufficient details to identify the nature and scope of the matter disclosed) in or under the Disclosure Letter”. The judge said that in this case, the sellers’ attempt to rely on fair disclosure as a defence was “nothing if not bold”. The only relevant disclosure was of a letter that seemed to show there had been a single breach of an environmental permit. There was no disclosure of historic and ongoing non-compliance, the provision of false data to the regulator, or the regulator’s warnings about possible prosecution. The takeaway: selective disclosure is not fair disclosure.
The SPA said that the sellers wouldn’t be liable for breach of warranty to the extent that certain individuals connected with the buyer had actual knowledge of the matter giving rise to the claim, with one of those individuals being the consultant the buyer had engaged to perform environmental due diligence on the target. This consultant knew about some historic breaches, but not that breaches were ongoing or that the regulator had threatened prosecution. The sellers argued that her knowledge of breaches over a long period of time meant she knew that there was a material risk of future breaches, and that the buyer therefore had knowledge of all relevant matters, albeit not of all the detail. Again this argument failed, reiterating the point that selective disclosure is a bad idea.
The SPA provided that the sellers were not liable for a warranty claim unless notice summarising the nature of the claim and, as far as reasonably practicable, the amount claimed, was given within two years of completion, except where the claim arose or was delayed as a result of the sellers’ dishonesty or wilful concealment. The sellers argued (correctly) that some of the claims had been notified late, and notice of another didn’t contain sufficient information about the amount claimed. The buyer had invoked the dishonesty carve-out on the claims that were notified late, but the sellers disputed this as well.
Warranty claims get thrown out on the basis of inadequate notice surprisingly often, but this one didn’t. The judge found that this particular clause set a low threshold. There was no requirement to set out the specific grounds of the claim or reasonable detail concerning the matters constituting the breach, nor to explain how the amount claimed had been calculated or how it was causally related to the matters complained of. And the time-barred breaches involved dishonesty and wilful concealment by one of the sellers. The takeaway: it is rare for a warranty claim to be litigated without an argument about proper notification of the claim: the importance of wording your notice requirement carefully, and adhering to it strictly, can’t be underestimated.
As it turned out the buyer’s misrepresentation claim was unnecessary: it had only been made to circumvent the notice provisions in the SPA had the sellers’ submissions about inadequate notice succeeded. But in defending the misrepresentation claim, the sellers argued that the “entire agreement” clause (which simply stated that the agreement constituted the entire agreement between the parties and superseded all previous discussions, representations etc) precluded a claim for misrepresentation. The judge disagreed: the purpose of that clause was to make it clear that nothing said, written or done prior to the SPA created contractual obligations or liabilities. It had nothing to do with reliance on prior statements, far less their existence, or with excluding claims of a non-contractual nature. Which brings me to our final takeaway: make sure your entire agreement clause contains four essential elements: a statement that the document contains the entire agreement, an acknowledgement of non-reliance on any non-contractual representations, an exclusion of remedies other than for breach of contract, and a carve-out for fraud.
Update June 2022
This case was appealed on how damages should be calculated; liability was not disputed. The Court of Appeal held that (1) where a buyer had been induced by deceit to buy something, the seller could not reduce its liability by showing that a contingency which reduced the value of the item at the date of purchase had transpired (2) a relevant consideration was whether, had the buyer known the truth, the buyer would have gone ahead at a reduced price or would have abandoned the deal altogether; the judge had not made a finding on this point so the case needed to be remitted for the judge to do so.