In the first warranty & indemnity insurance ("W&I") claim to be decided by the Commercial Court, the Defendant insurers succeeded on every issue, with the Court finding that there had not been a breach of the relevant warranties and indeed no loss as the buyer would have paid the full purchase price in any event.
Background
The Claimant, Finsbury, is a group of food manufacturing companies, including various bakery businesses. Finsbury brought these proceedings against the Defendant insurers under a Buyside Warranty and Indemnity Insurance Policy (the "Policy"). Finsbury had obtained the Policy to insure the sellers' liability in connection with its purchase of Ultrapharm – a specialist manufacturer of gluten free baked goods – from the shareholders of Ultrapharm pursuant to a Sale and Purchase Agreement ("SPA"). Both the Policy and the SPA were dated 31 August 2018.
Finsbury's acquisition of Ultrapharm was motivated by its desire to re-enter the "gluten free" ("GF") and "free from" ("FF") markets and Finsbury considered Ultrapharm's GF bread products to be the best tasting in that market. One of Ultrapharm's biggest customers was Marks and Spencer plc ("M&S").
Following the acquisition, Finsbury claimed that warranties provided by the CEO of Ultrapharm, Mr Marc Lewis, had been breached and that those breaches were covered by the Policy. Finsbury claimed more than £3 million from the Defendant insurers, which it said constituted the difference between the as warranted value of Ultrapharm and the actual value of Ultrapharm, at the time of its purchase on 31 August 2018.
The key issues to be decided by the Court were:
- Whether certain recipe changes and product price reductions
agreed to between Ultrapharm and M&S amounted to a breach of
the relevant warranties under the SPA (the "Trading
Conditions Warranty" and the "Price
Reduction Warranty" respectively).
- Whether, if any of the relevant warranties were so breached,
the relevant individuals at Finsbury had the requisite knowledge so
as to: (i) vitiate the sellers' liability for breach of
warranty under the SPA; or (ii) exclude the Defendant insurers'
obligation to provide indemnity under the Policy (the
"Knowledge Exclusions").
- What the loss, if any, was to Finsbury, and indeed whether if there was a loss on the purchase, Finsbury was responsible for that because it would have paid the full purchase price of £20 million for Ultrapharm even if it had known that its actual value was less.
Analysis of the Commercial Court decision
No Breach
In assessing the question of breach, the Court was faced with two key issues:
- The meaning of the words "material adverse change" for the purposes of the Trading Conditions Warranty.
- Whether the recipe changes and the price reduction (which fell to be considered pursuant to the Trading Conditions Warranty and the Price Reduction Warranty respectively) had been agreed and/or enacted prior to 31 December 2017 (the "Accounts Date"), for the purposes of giving effect to the words "Since the Accounts Date" in the warranties clause in the SPA.
In respect of the first issue, the Trading Conditions Warranty provided that since the Accounts Date there had been no material adverse change in the trading position of the target group or their financial position, prospects or turnover and no target group company had had its business, profitability or prospects adversely affected by the loss of any customer representing more than 20% of the total sales of the target group companies. The Court agreed with Finsbury's argument that, properly construed, these were separate warranties within the same clause and Finsbury was successful in arguing that the "material adverse change" referred to in the Trading Conditions Warranty, for which there is no set meaning that has been ascribed in the authorities, did not mean a loss of 20% in turnover which the Defendant insurers had argued for. The Court, however, did determine that a material adverse change must exceed 10% of the total group sales of Ultrapharm in order to constitute a breach of the Trading Conditions Warranty. The Court provided no reasoning for its finding of 10%, which, along with its reference to there being no set meaning of the words "material adverse change" in the case law, demonstrates that the inclusion of these words, without greater precision, may increase the uncertainty of where a court may draw the line in the event of a dispute. Despite the limited evidence of the financial impact of the recipe change before the Court, Mr Persey KC did conclude that the impact on the profitability of the two products which were subject to the recipe change could "not have amounted to anything like 10%" of total sales, and in any event recipe changes were part of the ordinary course of a bakery's business.
On the second issue, the Court was satisfied that the recipe changes had been agreed and implemented prior to the Accounts Date and the judgment records no argument from Finsbury as to that point. Finsbury did, however, argue that the price reduction, while agreed prior to the Accounts Date had not actually been implemented by 31 December 2017. Finsbury argued that the purpose of the Price Reduction Warranty was to "give the purchaser comfort that the true picture of Ultrapharm's position vis-á-vis its trade with customers is visible from the accounts prepared to the Account Date of 31 December 2017". The Defendant insurers argued that the natural meaning of the words "no Group company has offered or agreed to offer ongoing price reductions" [emphasis added] was clear and that implementation was not required. The Court found that argument to be compelling and concluded that the warranties clearly applied only to events which had occurred after the Accounts Date of 31 December 2017 for the purposes of protecting the position as between that date and the conclusion of the SPA. The existence of a Price Reduction Warranty of this kind, which includes wording about such a reduction being offered or agreed to be offered does not therefore protect a buyer against agreed price decreases that were yet to come into effect or avoid the need for a buyer to conduct the necessary due diligence beyond a review of product prices set out in the target's accounts.
"The SPA is not intended to be a panacea to resolve any unforeseen consequences of Finsbury's admittedly light touch approach to due diligence."
The impact of Finsbury's knowledge
The burden of proof was on the Defendant insurers in seeking to rely upon the Knowledge Exclusions, which were in fairly conventional form in requiring that a member of the buyer's transaction team had actual knowledge of the breach that is alleged to give rise to the loss. While "Actual Knowledge" was defined in the Policy and did not include constructive or imputed knowledge, it was ultimately common ground that it would nonetheless include wilful blindness (sometimes referred to as Nelsonian knowledge). Having found that the evidence of two key Finsbury witnesses relevant to the knowledge of a member of Finsbury's deal team as to the price reduction was "untruthful", the Court was satisfied that a member of the deal team did have sufficient information available to him for the Knowledge Exclusionsto apply.
No loss
The final question of substance considered by the Court was whether the buyer would have purchased the target for the same amount in any event. In this case, the Court was satisfied that Finsbury would have done so, based on the documentary evidence which showed that despite Ultrapharm's EBITDA falling over the course of the negotiations, the agreed purchase price never changed (or was sought to be changed) from its original figure of £20 million. This was the price that the sellers required and it was the price that represented the perceived value to Finsbury of Ultrapharm based on factors including its eagerness to re-enter the GF/FF market. Due to this finding, the question as to how to measure the as warranted value of the business was otiose. While the experts for both sides agreed that the conventional way to value Ultrapharm is by taking a conventional run-rate EBITDA multiplied by an appropriate multiple, the Court found it "appropriate to stress that [Finsbury, for the reasons referred to above] did not at the time seek to value Ultrapharm in the conventional way" and Mr Persey KC came to the conclusion that there was in fact "no "as warranted" value for Ultrapharm at the time the company was sold to Finsbury".
The impact of Finsbury's knowledge
The burden of proof was on the Defendant insurers in seeking to rely upon the Knowledge Exclusions, which were in fairly conventional form in requiring that a member of the buyer's transaction team had actual knowledge of the breach that is alleged to give rise to the loss. While "Actual Knowledge" was defined in the Policy and did not include constructive or imputed knowledge, it was ultimately common ground that it would nonetheless include wilful blindness (sometimes referred to as Nelsonian knowledge). Having found that the evidence of two key Finsbury witnesses relevant to the knowledge of a member of Finsbury's deal team as to the price reduction was "untruthful", the Court was satisfied that a member of the deal team did have sufficient information available to him for the Knowledge Exclusionsto apply.
No loss
The final question of substance considered by the Court was whether the buyer would have purchased the target for the same amount in any event. In this case, the Court was satisfied that Finsbury would have done so, based on the documentary evidence which showed that despite Ultrapharm's EBITDA falling over the course of the negotiations, the agreed purchase price never changed (or was sought to be changed) from its original figure of £20 million. This was the price that the sellers required and it was the price that represented the perceived value to Finsbury of Ultrapharm based on factors including its eagerness to re-enter the GF/FF market. Due to this finding, the question as to how to measure the as warranted value of the business was otiose. While the experts for both sides agreed that the conventional way to value Ultrapharm is by taking a conventional run-rate EBITDA multiplied by an appropriate multiple, the Court found it "appropriate to stress that [Finsbury, for the reasons referred to above] did not at the time seek to value Ultrapharm in the conventional way" and Mr Persey KC came to the conclusion that there was in fact "no "as warranted" value for Ultrapharm at the time the company was sold to Finsbury".
Key Takeaways
This case acts as an always important reminder that the courts will not use their interpretation of a contract to step in to save a party merely because the bargain it has struck, with the benefit of hindsight, is demonstrably ill-advised, or even disastrous. It also serves to demonstrate the particular importance of disclosure to insurers in W&I proceedings due to the information asymmetry between an insured party and the Defendant insurer and that the purpose of an SPA (and indeed, a W&I policy) is not to be a cure-all for a light touch approach to due diligence.
While breach was not established in this case, this case highlights the mistake it would be to assume that, in the event a breach of warranty is proven, a finding of loss will naturally flow. In this case, where the Court found there was no loss suffered, Finsbury's documents were particularly important in demonstrating how the purchase price for Ultrapharm was negotiated and the factors that were important to Finsbury in the transaction, in support of the Court's finding that Finsbury would have proceeded with the acquisition in any event.
Finally, and crucially, the judgment reiterates the principle that insureds (and deal teams) cannot rely on wilfully ignoring information that would lead to them having actual knowledge of a breach of warranty – a point for both insurers and insureds to bear in mind.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.