Warranty claim on alleged misleading accounts
09 September 2010
The purchaser was unable to show that the warranties given by one of the sellers as to the accounts were misleading. Even though the group of companies had incurred a substantial liability whilst under the sellers’ ownership, that liability had been unknown at the time of the sale. The accounts had been prepared in accordance with financial reporting standards and no damages were owing.
In September 2006, Macquarie bought from Glencore and two other companies all the shares in the parent company of a group that supplied energy (mainly gas) to the commercial sector (the Group). The sale took place by way of a sale and purchase agreement which contained warranties given by Glencore alone about the audited statutory accounts (the Accounts) and management accounts (the Management Accounts) for the year ending December 2005.
Unknown to any of the parties, one of the Group had incurred a liability to another energy company (X) during 2005. X acted as agent for gas transporters, calculating the daily volumes of gas supplied to and taken off the system by each gas company. X had introduced a new computer system to calculate these daily volumes and the charges incurred by each gas company. This new system contained an error which undercharged the Group company by some £2.4 million (called the ‘missed meters charge’).
Macquarie completed the purchase on 15 September 2006 and paid the purchase price at that time. X informed the Group company of the missed meters charge in November 2006. In January 2007, the Group duly paid the invoice issued by X in respect of the missed meters charge. Macquarie took the view that the non-disclosure of the liability constituted a breach of warranty and commenced proceedings.
First instance decision
At first instance (as set out in the Litigation Review in November 2009), Macquarie alleged that:
- the audited statutory accounts and the management accounts had not been prepared in accordance with relevant accounting standards;
- the Accounts did not give a “true and fair view” of the Group’s financial position; and
- the Management Accounts did not “fairly reflect” the Group’s financial position.
The purchase price was based on net asset value. Macquarie argued that, if the charges had been properly recognised in the Management Accounts, it would have paid less under the sale and purchase agreement.
Andrew Smith J held that there was not sufficient evidence available to the Group before 15 September 2006 of the existence of the missed meters charge for the purpose of making provision in the accounts. He held that although, in exceptional circumstances, accounts prepared in accordance with relevant accounting standards might not give a true and fair view, no such exceptional circumstances existed in this case. The Accounts had been prepared in accordance with relevant accounting standards and therefore provided a true and fair view of the Group. Given his finding that the missed meters charge was not known before 15 September 2006, Andrew Smith J also held that the Management Accounts “fairly reflected” the financial position of the Group. This was a less demanding test than a “true and fair view” because the parties intended there to be less demanding standards in relation to accounts prepared for internal management purposes. Andrew Smith J also determined that the missed meters charge was not material, as it represented a small proportion of the turnover of the Group as a whole.
Macquarie appealed on two limited points. First, although Macquarie agreed that the accounts had been prepared in accordance with relevant accounting standards, Macquarie argued that Andrew Smith J had erred in concluding that no exceptional circumstances existed to suggest that the accounts did not give a true and fair view of the financial position of the Group. Secondly, the judge erred in his construction of the second sentence of the Management Accounts warranty and had therefore incorrectly held that the Management Accounts did fairly reflect the financial position of the Group and were not materially misleading.
Agreeing with the decision of Andrew Smith J at first instance on the first point, the Court of Appeal found that compliance with published professional standards is strong evidence that accounts present a true and fair view. There were no exceptional circumstances in this case to suggest otherwise. At no time before the draft audited Accounts were signed off on 15 September 2006 did the Group have evidence of the missed meters charge which would have enabled it to be included in the Accounts. Indeed, the inclusion of such a charge would have meant that the Accounts were not prepared in accordance with the relevant accounting standards and put Glencore in breach of the warranties given. The Court of Appeal therefore concluded that the draft audited Accounts presented a true and fair view of the assets and liabilities of the Group. In relation to the Management Accounts, the existence of the liability remained unknown and not reasonably discoverable. The same reasoning therefore applied to the Management Accounts.
As to the second point the second sentence of the Management Accounts warranty stated:
“On the basis of the accounting bases, practices and policies used in their preparation and having regard to the purpose for which they were prepared, the Management Accounts: (a) fairly reflect the financial position of the Group as at 30 June 2006: (b) fairly reflect the cash and working capital position of the Group as at 30 June 2006; and (c) are not misleading in any material respect”.
Macquarie argued that this warranty must be interpreted from the viewpoint of a purchaser and not an accountant. Warranty (a) told Macquarie that the Management Accounts represented, with a reasonable degree of accuracy, the actual assets and liabilities of the Group, whether known or unknown and whether reasonably discoverable or not. With regard to (c), when viewed in terms of a purchaser, a discrepancy of £2.4 million would be highly material as a purchase price based on net asset value would be increased by 79%.
The Court of Appeal did not accept this argument. This was a warranty about the Management Accounts and it spelt out what those accounts represented, how they were prepared and with what degree of precision. Specific warranties existed as to the assets and liabilities of the Group, and Macquarie did not allege breach of these warranties. The Management Accounts warranty must be read as a whole as a warranty about the manner of preparation and degree of accuracy of the management accounts. Andrew Smith J had not erred in his interpretation. The appeal was therefore dismissed.
Comment: This case underlines the importance of choosing the language in an accounting warranty carefully. Concepts like “true and fair” are used widely in legislation and accounting standards, and the courts’ interpretation of the meaning of that language will be heavily influenced by the interpretation given to those concepts by the accounting community. In a similar vein, the courts have reiterated their position that compliance with published professional accounting standards is considered strong evidence that the accounts in question do represent a true and fair view. Parties to an agreement therefore need to be sure that they are happy to import such an interpretation. For example, if the parties are agreed that a warranty should extend to cover both known and unknown liabilities, the drafting needs to explicitly make reference to that fact.
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