Edwards Wildman Client Advisory - A Costly Warranty



    Making a tort misrepresentation claim on the basis of warranties given in a share purchase agreement can be one way of sidestepping the contract limitations on liability usually included in such agreements. In appropriate cases a tort claim can also provide a more favourable basis for calculating damages. However, as I explained in an article published in The In-House Lawyer, recent cases have made this more difficult. 


    The most recent decision has made clear that this is not necessarily a risk-free gamble. One of the cases considered in my article has just been back before the judge on questions of costs and he heavily penalised the claimant for its failed attempt to claim on the misrepresentation basis. In Sycamore Bidco Ltd v Sean Breslin and Another [2013] EWHC 583  (Ch) Mann J decided that, although the Claimant's  alternative contract claim for breach of warranty had succeeded, it should only be awarded 60% of its legal costs because its primary tort claim had failed.


    In Sycamore warranties were given about the accounts but it later became clear that they included various entries that were inaccurate or inappropriately categorised. Accordingly, the warranties were breached and the sellers were held liable under the contractual warranty provision to pay damages assessed on the contractual basis


    The tort misrepresentation failed because the judge found that the structure of the contract made clear that the warranties were intended to give rise only to a contract liability and tort liability was excluded. This made a large difference to the damages awarded. In part as a result of factors which did not arise from any breach of warranty, the target company had failed and so its shares were valueless. The tort claim was therefore for the entire contract price plus expenses. The contract claim succeeded but because it was calculated by reference to the difference between the value of the shares delivered and the value of the shares if the warranties had been correct, it was less than a third of the tort claim.


    The purchaser recognised the risk that it would only succeed in its contract claim and so, for protection, made a Part 36 offer. Part 36 is an English Court procedural rule that enables a claimant (there is a parallel procedure for defendants) to offer to settle the case on the basis that, unless accepted, the offer cannot be revealed to the court until issues of liability and quantum have been determined. However, if it is not accepted and the claimant successfully obtains judgment for an amount greater than offered the court will "unless it considers it unjust to do so":


    • order that the defendant should pay the claimant its costs assessed on the more generous indemnity basis (and prior costs will usually be ordered on the standard basis) and

    • calculate interest payable on the principal claimed and costs payable at a rate 10% above base rate.


    The amount awarded in damages exceeded the amount of the Part 36 offer. However, the Court applied the consequences of the Part 36 offer only to the costs as they had been reduced to reflect the failure of the tort claim. Although there had not been binding authority requiring this approach, the Claimant's counsel conceded that it was correct and the Judge commented that she had been correct to do so.


    The case gives another salutary lesson, this time for those giving warranties jointly with other sellers. The share sale agreement provided that one of the sellers was only liable for a portion of the damages for breach of warranty. That seller argued that the very substantial cost liability to the claimant should not be imposed on him at all because no extra costs had been incurred suing him, or that, if any costs were to be ordered against him they should be reduced to reflect his proportion of the overall damages liability. The judge disagreed and ordered that defendants should be jointly liable for the costs. As a result although the damages liability of this defendant was less than £300,000, he was "liable for millions of pounds in costs".


    A right of indemnity for such a junior seller may prove to be cold comfort if the senior seller is insolvent by the time a costs award is enforced. Where the senior seller stands to gain significantly more from the sale than the junior seller the latter may wish to require the purchase of legal costs insurance to protect himself against the scale of costs liability which the junior seller in Sycamore had to bear.


    Insolvency will also be a concern for the purchaser as the warranties are only worth what the seller is eventually able to pay. Sophisticated purchasers will include that factor in their evaluation of the transaction. However, they may be surprised to learn that they may be forced to accept the risk of a limited recovery from a wholly solvent seller. In Ricoh Holdings BV v Spratt & Anor 2013] EWCA Civ 92 the seller had given a tax indemnity in the sale agreement. A tax investigation was subsequently commenced and it was likely that this would lead to a liability under the indemnity, although the full amount of the tax due would not be known until the investigation was complete, which was likely to be sometime in the future. The seller was placed into members voluntary liquidation, a form of insolvency procedure only available to companies which are fully solvent.


    The purchaser proved in the liquidation for the maximum prospect of liability under the tax indemnity. The liquidator admitted the claim to proof but valued it at a fraction of that maximum liability and proposed to distribute the assets of the company on that basis, with the result that, if the tax payable was eventually found to be greater than estimated by the liquidator, the purchaser's claim for the difference between the liquidator's estimate and the true claim would be unsatisfied.

    The Court decided that the liquidator was not only entitled to act in this way but was bound to do so. It follows that, provided that the valuation of a contingent claim can be undertaken properly and fairly, a purchaser's claim which has not yet been fully quantified can be reduced and limited by the members voluntary liquidation procedure.

    If you would like further information, please contact the Edwards Wildman lawyer responsible for your matters or the author linked above.


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