Two recent decisions - one from the Court of Appeal and another from the Commercial Court - consider aspects of breach of warranty claims made under Share Purchase Agreements (SPAs). Both bring learning points in relation to the all-important step of giving notice of breach to the seller; in particular, around the drafting and construction of underlying notice of claim clauses and the interaction between warranty claim notice periods and the contractual limitation regime, where there are earn-out provisions in an SPA.
Our guidance continues to be that when giving notice of a breach of warranty under an SPA, you must take care to comply with the contractual requirements (although the decision in Drax Smart Generation Holdco Ltd v Scottish Power Retail Holdings Ltd will give some comfort to parties seeking to comply in circumstances where facts continue to emerge). In this briefing, we look closely at the details of the SPA and notice of claim in each case, the Court's findings and what this will mean for future breach of warranty cases.
Key points in Drax Smart v Scottish Power
Notice of claim clause
In Drax Smart Generation Holdco Ltd v Scottish Power Retail Holdings Ltd the Court of Appeal reversed the lower Court's decision to strike out a breach of warranty claim under an SPA. This decision turned on the construction of the notice of claim clause under the SPA. Notice of claim clauses routinely create a bar for a claim, unless notice is given within a specified time limit. They usually require the notice to state 'the nature of the claim' and sometimes require this to be done 'in reasonable detail'.
The SPA in this case provided that unless the buyer notified the seller of the claim by a specified deadline, the seller would not be liable. The notice required the buyer to state "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 buyer gave a nine-page-long notice setting out a large amount of information, including details of the likely heads of loss and an estimate of those losses. Despite this detail, the seller contended the notice was insufficient, because it should have spelt out that the damages claimed would be based on the difference in value of the shares in the company as a result of the breach of warranty.
High Court decision
The High Court found in favour of the seller. It decided that the wording of the notice of claim provision required the buyer to detail its loss in terms of diminution in the value of the shares in the target company (the well-established basis for quantifying loss in a breach of warranty claim), as the buyer later set out in its Particulars of Claim.
There were two applications before the High Court judge: Scottish Power applied for reverse summary judgment, and Drax applied for permission to amend the Particulars of Claim. Both applications turned on whether reformulated claims in draft Amended Particulars had a real prospect of success. On the basis of the judge's finding above, the High Court dismissed the breach of warranty claim. (The judge took a different view in relation to an indemnity claim, concluding the basis of that claim was sufficiently identified in the notice of claim).
Court of Appeal decision
The Court of Appeal did not agree with the High Court. It decided that the buyer's claim for damages was not barred by the notice of claim clause. It dismissed the seller's application for summary judgment and granted permission to the buyer to amend its Particulars of Claim.
As is the case with other provisions of an SPA, the usual rules of contractual construction will be applied to determine what is required to comply with a notice of claim clause. The judges in the Court of Appeal all agreed that there was nothing in the language of the clause, or in its commercial purpose, that required the buyer to accurately specify the quantum of damages, as part of a statement as to the nature of the claim. In these circumstances, for the Court to insist on such a statement for the notice to be valid would serve no commercial purpose and would introduce an unjustifiable trap to defeat what may be a valid claim.
The Court of Appeal explained that the initial purpose of notice of claim clauses is to provide a contractual limitation period for the parties to work to, which will generally significantly precede statutory limitation periods for claims. If no notice is given by the stated deadline, the parties can close their books on the transaction, which promotes finality and certainty in commercial dealings.
The language used when drafting the notice of claim clause is therefore key. The Court ruled that notice of claim clauses should essentially be treated as exclusion clauses and accordingly: (a) such clauses are liable to be narrowly construed; and (b) commercial parties will not lightly be taken to have intended to cut down the rights and remedies available under the contract without clear wording to that effect. The judge commented, "It is important that Notice of Claim clauses should not become a technical minefield to be navigated, divorced from the underlying merits of a buyer's claim".
Key points in Onecom v Palmer
In Onecom Group Ltd v Palmer, Onecom sued for alleged breach of warranty by Mr Palmer in respect of an SPA under which it purchased the entire share capital of another telecommunications services company. Mr Palmer sought summary judgment and/or strike out on the basis that the warranty claims were time-barred, pursuant to the contractual limitation regime set out in the SPA. This case primarily turned on the interaction between the procedure for determining the seller's entitlement to deferred consideration under an earn-out mechanism and the provisions dealing with the requirements for notification of a breach of warranty claim under a notice of claim clause (i.e. compliance with the same sort of provision which was considered in the Drax case).
The parties agreed to value the business on the basis of a (relatively standard) EBITDA (earnings before interest, taxes, depreciation and amortisation) multiple approach. As they could not agree an appropriate final EBITDA figure, they included an earn-out mechanism in the SPA, pursuant to which a further payment would be due to the seller if the business performed above a predetermined level within 12 months of the completion date. Earn-out mechanisms (as with any deferred consideration arrangements) are, routinely, heavily negotiated and can be prime territory for disputes (particularly given that the operation of the business in the hands of the buyer can dictate the amount ultimately paid to the seller).
To resolve any such dispute, it was agreed that if the parties were unable to agree the amount of the earn-out payment, they would refer the matter to an independent expert (as happened in this case).
The SPA contained a number of warranties and, as is to be expected, contained associated provisions for the protection of the seller, which required: (i) written notice of a warranty claim to be served on the seller, giving reasonable details of that claim, within 24 months of the completion date; (ii) any claim to be commenced within six months of the giving of the claim notice ("the litigation period", commonly referred to as a "put up or shut up" provision); and (iii) if a warranty claim was based on a contingent liability, or was not capable of being quantified at the time when notice was given, the seller would not be liable to make payment unless and until the liability became actual or capable of being quantified.
The seller gave notice that he disputed the earn-out accounts, identifying the disputes and setting out his own calculations. The parties could not resolve the disputes and they were referred for expert determination. Three months later, the buyer served a notice of claim for breach of warranty. There was overlap in the nature of the items in dispute for the warranty claim and those included as outstanding matters for the expert determination, which both parties acknowledged in pre-action correspondence. The parties had, however, been unable to agree terms for an extension of the deadline by which proceedings had to be commenced, pursuant to the SPA.
When did the litigation period start to run, and what action was required by the buyer to preserve its claims?
The buyer started legal proceedings one day before the end of the litigation period (seemingly to preserve its position and avoid its claim becoming time-barred) and, subsequently, successfully applied for an extension of time to serve the claim form on the seller due to the ongoing expert determination process in relation to the earn-out. The independent expert reached a decision and issued its report, following which the buyer confirmed to the seller that it could quantity its breach of warranty claims and served the claim form (within the validity period).
The seller claimed that the buyer was time-barred from commencing legal proceedings as the claim form, notwithstanding the fact that it was valid for the purposes of the Court rules in light of the extension, had been served after the end of the litigation period. The seller contended that the buyer's claim was therefore time-barred by virtue of the notice of claim provision. This gave rise to the seller's application for strike-out or summary judgment.
The buyer claimed that the claims fell within the litigation period, as they were contingent and unquantifiable until the point at which the independent expert delivered its report. The buyer also argued that the litigation period began on the date of the independent expert's determination as to the earn-out payment and was not time-barred.
The Court agreed with the buyer. The claims were contingent and unquantifiable until the independent expert's decision had been reached and, therefore, the litigation period had not begun in line with the terms of the SPA. There was a risk of double-counting where the subject of the warranty claims overlapped with the earn-out calculation, and this was, therefore, precisely the sort of circumstance that the notice of claim provision is designed to address through its mechanism for adjusting time limits for contingent claims. The seller's applications for strike-out and/or summary judgment were refused, and the claim continues.
How will the outcome of these decisions impact future breach of warranty cases?
It is imperative, particularly given the risks of seeing an otherwise valid and valuable claim become time-barred, that notice of claim clauses are followed closely by buyers when notifying claims. However, both of the decisions above represent pragmatism from the Courts and will provide some comfort for buyers.
Collectively, they demonstrate that the Court will seek to avoid being unnecessarily dogmatic or permit sellers to avoid liability where a notice is within the scope of the requirements. Caution still needs to be exercised, however, and there is opportunity for respective parties to advance their position during the drafting of these clauses in the SPA, as the precise language used in the notice of claim clause will be key in any given case. The Court's decisions and pragmatism in these cases should not be mistaken for an indication that it will rewrite a commercial bargain for the buyer who finds itself having served an ineffective notice. Equally, sellers seeking to take overly technical points in an attempt to avoid liability, particularly where they have been given detailed notices (including sufficient detail to allow them to assess their liability and seek legal advice) should heed the potential costs exposure they face by fighting those points through costly proceedings.
To read further about the importance of ensuring contractual notice provisions are strictly adhered to, see our related articles on the interpretation of warranties:
- Court of Appeal: No Material adverse change...but notice of breach of warranty ineffective in any event!
- How do I notify a breach of warranty claim?
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