How breach of warranty claims can arise and be pursued

In an SPA the buyer agrees to purchase the share capital of the target company from the seller or sellers. During this process, the buyer seeks protection through various means, including due diligence – thorough investigation of the target company - warranties, indemnities, and the disclosure letter.

A warranty is a contractual statement or assurance given by the seller to a buyer that a certain state of affairs exists. For instance, it may include assurance that the company is not engaged in any disputes or criminal proceedings and there are no such proceedings pending, threatened, or expected either by or against the company.

There are both general warranties, which relate to the target company’s business or its accounts as a whole, and specific warranties, which relate to particular parts of the target company.

In the event that the seller gives a warranty that is inaccurate or misleading, the buyer may have a contractual claim for breach of warranty against the seller.

Disclosure

The warranties are given subject to what is disclosed in the disclosure letter. This letter is the means by which the seller discloses qualifications to the warranties and thereby limits their scope. Disclosures are made by reference to each of the warranties and are a way of making the buyer aware of particular issues before it decides to purchase the shares.

Before bringing a claim, a buyer will need to carefully check that the breach it alleges has not already been disclosed in the disclosure letter. If it has, this knowledge could prevent the buyer from bringing a claim in relation to that particular warranty.

Time and financial limits and considerations of a claim

The SPA will usually contain time limits, both in respect of notifying any potential claim and also when proceedings must be formally issued and served. A claimant will need to be careful to adhere to these timeframes, which are strictly interpreted and if missed usually prevent a claim being brought.

Restrictions can also be put on the value of the claim or claims being brought. Often these require a certain financial limit to be met before a claim can be brought. This prevents minor claims of low value being brought.

An SPA may also include a maximum liability of the seller in respect of some or all of the warranties. In addition, warranty and indemnity insurance may prevent a claim being made, so buyers should carefully check the terms of the SPA.

Other practical steps to investigate any potential claim involve examining the warranties contained in the SPA to identify their exact wording and what they relate to. Any limitations on bringing a claim must be identified while determining what loss has been suffered.

Notification of claim

If the buyer(s) considered that they have a valid claim, the claim needs to  be notified. It is extremely important that the notification complies fully with the requirements contained in the SPA.

The SPA imposes a time limit specifying the deadline for notifying any  breach of  warranty claims  to the seller. This is usually much shorter than the statutory limitation period, for example two years to notify a claim, rather than six years which is the usual position for breach of contract claims. Courts expect claimants to strictly adhere to these time limits, which means that a potential breach of warranty claim needs to be investigated in good time.

The purpose of the notice is to ensure that the seller knows and fully understands the nature of the claim. An SPA usually requires that a notice contains ‘reasonable detail’ of the particular warranty alleged to have been breached. The reason or reasons why the buyer consider that the warranty has been breached needs to be detailed in the notification. Claims should try to avoid casting the net too wide to ensure that the grounds of the claim are clearly set out by reference to specific warranties.

The specified method of service also needs to be used. The courts expect notification provisions in contracts to be strictly adhered to in order to be valid. Time should be allowed to establish the necessary method of service and to effect it.

Bringing a claim

Once notice has been served and the seller is aware of the claim, the claim could be settled or withdrawn. If not, formal legal proceedings would need to be issued and served if the claimant wants to progress the claim.  

The SPA will specify a date by which proceedings should be issued and served.

It is important to note the distinction between the deadline for the contractual notice of the warranty claim under the SPA and formally starting proceedings before the court. Failure to adhere to either deadline could result in the buyer being unable to pursue the claim.

Given the importance of adhering to the timeframes set out in the SPA, it is important to think ahead about service of the claim form. For instance, it may be important to consider where the seller is located, whether permission is required to service out of the jurisdiction and whether the seller has nominated an agent of service.

It is also necessary to consider whether the SPA contains a conduct of claims clause. This provides rights to a seller in relation to the conduct of any third-party claims that may arise after completion of the sale which could result in a claim being made by the buyer against the seller under the SPA. The rationale for this approach is that the financial consequences of such third-party claims may ultimately be passed on to the seller via a warranty or indemnity claim, and so the seller needs assurance that they will be handled properly and in a manner which aims to minimise the seller’s liability.

Before issuing proceedings, a buyer should consider the commercial implications of bringing a claim. For instance, considering whether the seller has the financial means to pay any damages awarded, or involved in the target company in some way, such as being an employee, director, or consultant. A buyer should carefully consider how any claims, both actual and threatened, may impact that relationship and if the recovery sought outweighs the potentially commercially damaging impact of the claim.

It is important to take legal advice on this process in order to ensure that any claim is made within the timeframe and adheres to the requirements of the SPA.

Assessing loss in a breach of warranty claim

The principle of assessing loss for a breach of warranty claim is consistent with the normal principle of compensatory damages. The aim is to put the buyer into the position it would have been in had the warranties been true.

This will likely include compensation for any loss. This is generally calculated as the difference between the position the buyer would have been in had the warranties been true (often the value of the company bought) and the position they are actually in as result of a breach of warranty. This may include comparing the actual and potential market value of the company. However, this is only the starting point, and the seller may be able to argue that the buyers would have still paid the same price for the shares had they been aware of the breach of warranty due to considerations above and beyond the market value of the company, such as diversification of the buyer’s business or removing a competitor from the market.

Professional legal advice should be taken to ensure the loss is assessed correctly. Expert evidence is often required to assess the value of the claim.