Take notice: the importance of complying with formal notification requirements
A recent judgment of the High Court has highlighted the potential hurdles thrown up by notification clauses in share purchase agreements.
When purchasing shares, it is common for buyers to seek and sellers to give warranties as to the shares being acquired and the business of the target company or group. While warranties serve a useful purpose for eliciting the disclosure of information, recovery for breach of warranty has always been difficult.
In particular, the standard practice for share purchases under English law has been for warranty claims to be based on damages for breach of contract – the recoverable loss is, broadly speaking, the diminution in value between the value of the acquired shares if the warranty had been true and the value of the acquired shares on the basis that the warranty is false. For further detail of how losses are assessed, see What's the Damage?
An obvious consequence is that the loss suffered by the target company in relation to a matter that constitutes a warranty breach is not a sufficient basis for the buyer to make a recovery. Rather, the buyer must demonstrate that the warranty breach would have meant a lower value would have been ascribed to the shares had it known of the relevant matter.
Even before reaching the stage of quantifying losses on this basis, which typically requires expert evidence to assess the valuation of the shares, there are hurdles a buyer must overcome to make the relevant claim. A share purchase agreement typically contains provisions limiting the seller's liability for warranty claims (usually by setting a financial cap and a time limit on making claims) and setting out how the buyer may make a valid claim. These provisions are normally carefully negotiated. One of the ostensibly more innocuous provisions is a notification clause, which interacts with the time limit – often this will take the form that if the buyer wishes to make a warranty claim, then it must notify the seller of the alleged breach of warranty before the end of a specified timeframe, and set out certain information relating to the claim. The provisions will often go on to say that having notified a claim, the buyer then has a fixed period within which to issue proceedings or else the claim is extinguished.
In Drax Smart Generation Holdco Limited v Scottish Power Retail Holdings Limited  EWHC 412 (Comm), the High Court highlighted the importance of compliance with a notification clause, with failure resulting in summary judgment being granted in favour of the defendant seller.
Drax Smart Generation Holdco Limited v Scottish Power Retail Holdings
This case concerned the acquisition of a target company under a share purchase agreement. While multiple claims were made, the key claims for the purposes of this blog concerned an option agreement which had been warranted as having been assigned to the target company, which was subsequently discovered not to have been the case. The buyer also had a potential indemnity claim in relation to the same subject matter.
In the High Court, the seller made an application for summary judgment against the buyer on the basis that, the relevant notification clause under the share purchase agreement having not been complied with, the buyer had no reasonable prospect of succeeding on the claim. The relevant notification clause stated:
"In the case of the types of claim detailed below, the Seller shall not be liable for a claim unless the Buyer has notified the Seller of the claim, stating in reasonable detail the nature of the claim and the amount claimed (detailing the Buyer's calculation of the Loss thereby alleged to have been suffered)."
The crucial elements required to be included in a notice of claim under this clause were:
(a) the nature of the claim; and
(b) the amount claimed, detailing the calculation of the loss,
in each case, in reasonable detail.
The buyer was further required to issue proceedings within six months following the giving of notice of a claim, or, if its loss was contingent or unquantifiable, within six months from the loss ceasing to be contingent or quantifiable.
The buyer gave a nine-page notice of claim to the seller within the relevant timeframe specified in the share purchase agreement. The notice of claim had been drafted by the buyer's solicitors, setting out the relevant factual background to its claims, specifically referring to the relevant warranties and to the buyer alleging that those warranties had been breached. The notice of claim further stated that while the losses were unquantifiable, the buyer expected losses to fall into certain categories and gave current estimates as to what the losses might be. These included losses suffered directly by the target company, and which it was stated the buyer itself would in turn suffer (implying some arrangement by which the buyer had indemnified or otherwise assumed the relevant liabilities of the target company). The notice of claim did not make any reference to the diminution in value of the shares in the target company, and some of the categories of losses were stated to be estimates of future losses.
Taking the contents of the notice of claim in the round, the Court decided that the buyer had not given reasonable notice of the nature of the claim. It was not sufficient for the buyer to set out that it was making a claim for breach of warranty, but rather, the buyer needed to state how it had suffered loss. That loss needed to be based on a diminution of value, but in the notice of claim the losses referred to were either direct losses of the target company or losses as a result of assumption of liability or indemnity by the buyer, and in some cases, were future losses. Without stating that the claim being made was for diminution of value, the buyer had also not provided reasonable detail of the calculation of the loss. The seller was therefore not in a position where it could understand the nature of the claim being made, and the commercial purpose of the notification clause was not met by the notice of claim it had received.
In a helpful passage, the judgment goes into detail as to the commercial importance of complying with the formal notification requirements in the share purchase agreement:
"The commercial purpose of the notification clause included enabling the recipient to understand the claims being made, including understanding the basis for the amount of the claim; to make such inquiries as it is able, and would wish, to make into the matters relating to the amount being claimed, potentially with a view to gathering or preserving evidence; to assess so far as possible the merits of the claim; and to take into account the nature and scope of the claim in its future business dealings, whether by way of formal reserving or a more general assessment of the potential liability; and potentially to seek to resolve the claim. In order to fulfil those purposes, it was necessary for [the buyer] to state what the basis was of its claim for loss."
The notification clause in this case was not overly onerous, and was fairly standard for a share purchase agreement. Failure to comply with that clause was a full barrier to recovery for a warranty claim. This might initially seem harsh, but as the judgment makes clear, the notification provisions do have a commercial purpose and will be construed in that light. This serves as a reminder that even for one of the less contentious parts of a liability package, due care needs to be taken as to the meaning of the words used when drafting the provision. When things go wrong and a claim needs to be made, similar care needs to be taken as to ensuring that a notification complies with the wording of the notification clause and takes account of what commercial purpose the clause seeks to achieve.
When it comes to drafting contracts and notification clauses, sellers and buyers will have different interests. The seller is seeking to limit the circumstances of its liability and may well seek to make the notification requirements as wide as possible – for example, in addition to requiring details of the nature of the claim and the loss suffered, it might also require the buyer to state the grounds of the claim, the matters and circumstances giving rise to the claim, steps taken to mitigate losses, or other specific details. The seller will also likely want to include all types of claims in the notification requirements.
The buyer, on the other hand, is seeking to have a simple set of notification requirements which it can easily follow without inadvertently failing to comply – and if the seller insists on complicated and detailed requirements, then it might seek to state that failure to give reasonable detail should not invalidate notice of a claim. In contrast to the seller, the buyer should wish to limit the notification requirements to warranty claims only.
From either perspective, the importance of getting the words correct can make the difference between a successful claim or defence.