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Contractual notice of warranty claim

05 May 2015. Published by Geraldine Elliott, Partner

In The Hut Group Limited v Nobagar-Cookson[2], the High Court considered what was required to comply with a provision in a share purchase agreement requiring notice to be given of a breach of warranty claim.

The court also considered the circumstances in which acts and omissions (in this case, fraud) by natural persons can be attributed to a company and how damages for breach of warranty should be calculated.

Facts

The claimant was the online retailer The Hut Group Limited (THG) and the defendants Mr Oliver Nobahar-Cookson (Mr Cookson) and Barclays Private Bank and Trust Limited, trustee of Mr Cookson's family trust in Jersey (the Trust).  In 2011, THG bought an online sports nutrition business owned by the defendants, Cend (trading as "My Protein"), pursuant to a share purchase agreement of 31 May 2011 (SPA).

In consideration for the sale of their shares in Cend to THG, the defendants received cash consideration and equity in the combined business by way of shares in THG.

THG claimed that the defendants were in breach of warranty relating to Cend's management accounts.  The defendants warranted in the SPA that those accounts had been prepared in a way which was consistent with the preparation of its statutory accounts and gave a true and fair view of the company's financial position. However, THG claim that seven adjustments to the accounts were required in order for them to comply with the warranty.

The defendants rejected the claim contending that:

  • THG's warranty claim was time-barred because it had not complied with the notice requirement in the SPA. This required the buyer to serve notice of the claim, specifying in reasonable detail the nature of the claim (and, so far as practicable, the amount claimed), within 20 business days of becoming aware of the matter. The defendants argued that, on the proper construction of the clause, THG was required to give notice when it became apparent it might have a claim. On this construction, it had failed to notify the defendants of its claim in time. THG argued that it was only required to notify the defendants when it was aware it had a proper basis for making an actionable claim;
  • The notice given by THG was not valid because it did not contain sufficient detail. It understated the amount claimed (for tactical reasons) and contained no information about the basis of the calculation.    

The defendants brought a counterclaim asserting that THG was in breach of the buyer warranties it gave in the SPA relating to the value of the consideration shares in THG. THG admitted liability for the breach which was caused by an accounting fraud by its financial controller (leading to the EBITDA of the company being overstated by £5.6m). THG contended that the fraud could not be attributed to the company so that a contractual cap on its liability under the SPA of £7.24m applied.

Decision

THG's breach of warranty claim and allegation of its late notification

The court held that, on the facts, the defendants had breached the warranty relating to Cend's management accounts. The judge agreed with THG's contention that it only became "aware of the matter," and was so required to serve notice on the defendants, at the point at which it was "aware that there was a proper basis" for putting forward a warranty claim. This was commercial sense; without knowing that a claim has a proper basis, a party to a share purchase agreement would not expect or wish to notify the other party of it.  In other words, it cannot have been the parties' intention to require notice to be given every time a party became aware of facts which might form the basis of a breach of warranty claim.

Did THG's notice provide "reasonable detail" of the nature of its claim and "so far as practicable" the amount claimed?

The court held that the notice given by THG contained sufficient detail of the claim and thereby complied with the SPA's requirements as to the content of the notice. The judge stated that "not much was contractually required" to meet the "reasonable detail" threshold of the clause and that THG had provided all that was practicable by way of quantification at this stage.

Quantum of THG's claim

As to the measure of damages for THG's claim for breach of warranty, it was common ground that any loss suffered by THG would be quantified as the difference between:

  1. (a)The "warranty true" valuation of Cend (i.e. assuming no breach of warranty); and
  2. (b)The "warranty false" valuation of Cend (i.e. assuming the accounts warranties were false to the extent that the adjustments contended for were necessary).

The parties agreed, and the judge found, that Cend's "warranty false" value was an arithmetical exercise which should be calculated by reference to a multiple of Cend's EBITDA. THG argued that a discounted multiple should be used because the existence of errors in the accounts called into question the accounts as a whole, and further issues could arise which would lower the value of the business to the buyer.  Using the reduced multiple would have the effect of reducing the "warranty false" valuation and so increase the difference between the two values.  However, the judge did not accept THG's arguments on this point in light of the factual evidence.  He found that a discounted multiple would produce an unrealistic valuation of THG's loss, and he instead applied the original transaction multiple of EBITDA.  

Defendants' counterclaim

Valuation

The Trust had acquired the consideration shares in THG, which represented a minority shareholding in THG.  The value of the counterclaim was dependent on the same principles as applied to the claim, in relation to the THG consideration shares.  The court went through the exercise of valuing the shares on a warranty false basis.  One issue for determination was the extent to which the court should take account of matters following the breach in assessing loss.  THG contended that the company was doing well, that the Trust still had its shares, and that therefore it had suffered no loss.  The basic principle is that the loss is suffered and damage should be assessed at the date of breach.  The judge concluded that improvement in the state of the company following breach did not affect that conclusion. The court found that the present case was distinguishable from The Golden Victory [2007] 2 AC 353 in which it was held that where value depends on the outcome of a future contingency, the known outcome of that contingency may sometimes be taken into account, but only where 'necessary to give effect to the overriding compensatory principle'.

The fraud

The attribution of acts and omissions by natural persons to a company was a matter of construction in each case.  The court found that THG's financial controller had been heavily involved in the transaction.  He had provided the financial information on THG which was essential to the deal proceeding.  It was irrelevant that he was not a "front facing" member of the deal team. Other members of the finance department were also involved in the fraud.  In those circumstances the judge concluded that the fraud (the admitted breach of warranty) could be attributed to the company.  As a result of this finding, THG was not afforded the protection of the £7.24m contractual cap on liability for breach of warranty.

Finally, as to the measure of damages for the defendants' counterclaim, Blair J held that the defendants' loss should be assessed at the time of the breach and should not, as THG had argued, take into account the fact the defendants stood to benefit from the future sale of THG.

Comment

Normal principles of construction apply to these type of contractual notice clauses in an SPA. The clause will be given its 'natural and ordinary meaning'.  Practitioners involved in breach of warranty and other post M&A claims will need to consider each clause on its terms.  However, the wording of the clause in the present case is commonly used in share purchase agreements so the case   provides useful guidance on the interpretation of such a contractual notice provision.  In particular, it is interesting to note the judge's comment that "nothing much" was required for the purposes of providing information of the nature of the claims under the notice clause, despite the clause specifying that "reasonable detail" was required.  

The case also demonstrates the potential scope for sellers to argue that a buyer's claim should fail for want of complying with a notification clause.  In light of this, whilst commercially buyers commonly agree to a time limit on notifying claims, the particular provision should be carefully drafted to avoid any ambiguity as to when time starts to run, and also as to what exactly is required to be notified to found a claim.  In the adrenalin rush of securing and signing a commercial deal it is easy to pay less attention to what appear to be boiler plate clauses at the end of the share purchase agreement.


[1] [2014] EWHC 3842