The High Court of Justice recently considered two disputes regarding breaches of warranties arising from the acquisitions of private companies. The decisions affirm the orthodoxy that the measure of damages for breach of warranty included in a sale and purchase agreement for the sale of shares is the diminution in the value of the shares purchased but also sound a warning to sellers that have struck a poor economic bargain.
In 2009 Oversea-Chinese Banking Corporation Limited (OCBC) entered into a sale and purchase agreement with ING Bank NV (ING) to acquire ING Asia Private Banking Limited (IAPBL). IAPBL had a financial exposure to Lehman Brothers Finance SA under equity derivative transactions entered into in 2006. Obligations under those transactions became payable in 2008 following the bankruptcy of Lehman Brothers Holdings Inc. A dispute arose in connection with the calculations made by IAPBL on early termination of the equity derivative transactions. Pursuant to a settlement in 2012, IAPBL had made a payment of $14.5 million to Lehman Brothers Finance SA.
ING had warranted that IAPBL's 2008 accounts gave a true and fair view of IAPBL's state of affairs. OCBC submitted that, but for the breach of the accounts warranty by ING, the true accounting position would have been disclosed to OCBC with the result that a suitable indemnity in favour of OCBC would have been included in the sale and purchase agreement in respect of IAPBL's liability to Lehman Brothers Finance SA. OCBC claimed that diminution in value is not the only measure for breach of warranty in connection with the sale of shares. Instead, it claimed that the normal measure of damages for breach of the accounts warranty is the estimated loss directly and naturally resulting therefrom, which was $14.5 million.
The court determined that OCBC's measure of damages could not be recovered as a matter of law.(1) The accounts warranty was a warranty of quality and the measure of damages for breach of such a warranty in a sale and purchase agreement is the difference between the true value of the asset and its value with the quality warranted. The court found no basis in previous decisions or textbooks to support the claim advanced by OCBC that the measure of damages for a breach of warranty of quality on a share sale could be the amount which could have been claimed under a hypothetical indemnity. While acknowledging that it may be necessary to adjust the valuation methodology to determine the loss of bargain suffered by a claimant for breach of warranty as to quality on a share sale, the orthodox position was affirmed that the measure of damages is the diminution in value of the shares purchased.
In 116 Cardoman Limited v MacAlister(2) the court considered, among other things, the quantification of damages for breach of a warranty that the accounts of an insurance company gave a true and fair view of the company's state of affairs. The parties had also agreed two financial limitations on the liability of the sellers: the purchase price of approximately £2.3 million was the maximum aggregate sum recoverable for any claim for breach of warranty and the first £500,000 of any claim was not recoverable. While the hurdle (or basket) was high relative to the purchase price paid, the background facts may be taken to suggest that the sellers had been willing to accept a reduced price in return for being shielded against all but large claims.
The court concluded that the accounts warranty had been breached and affirmed the orthodox measure of damages in respect of such breach as being equal to the difference between the value of the shares as warranted and the actual value of the shares. However, on the facts, the court rejected that the purchase price represented the value of the shares as warranted. The parties had completed the transaction on an expedited basis at an undervalue and expert evidence supported the conclusion that the as warranted value of the company was more than £500,000 more than the purchase price paid by the purchaser. Since it was concluded on the facts that the actual value of the shares was zero, the purchaser was awarded damages equal to the purchase price.
In addition to affirming the orthodox measure of damages for breach of warranting included in a sale and purchase agreement, the court's decision is relevant to acquisitions of private companies in the following respects:
- The contractual limitation on liability of the sellers had been upheld despite the buyer's losses being substantially greater agreed on cap. Therefore, a suitably drafted cap on the damages recoverable for (non-fraudulent) breaches of warranty, consistent with customary practice, should protect a seller.
- The interaction between the basket of losses that must exist for a claim to proceed and the aggregate cap on liability should be considered carefully, especially if the circumstances of the transaction may be unusual. The specific terms of the sale and purchase agreement were not included in the judgment but, since the basket appeared to operate in a manner comparable to an insurance deductible, it is possible that the sellers had anticipated that their maximum liability under the sale and purchase agreement would be equal to the purchase price less the £500,000 basket. However, since the court considered the sellers to have struck a bad financial bargain by selling at an undervalue, their aggregate liability was equal to the purchase price without deduction of the basket.
- To calculate the loss arising from the breach of warranty, the court had to determine the valuation of the company which was affected by inaccuracies in its historic financial information. At the time of entering into the sale and purchase agreement none of the parties were aware of such inaccuracies, but the uncertainties as to valuation that arose as a consequence might have been mitigated if the sale and purchase agreement had specified the basis on which the valuation of the company had been reached.
Endnotes
(1) Oversea-Chinese Banking Corp Ltd v ING Bank NV [2019] EWHC 676 (Comm).
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