In corporate acquisitions, references to 'representations and warranties' abound. Even though these terms are sometimes used interchangeably, (perhaps as shorthand), in law 'representations' and 'warranties' are quite different. A recent case illustrates just how important the difference between the two can be, with more than US$ 500 million turning on it.
Idemitsu Kosan Co Ltd v Sumitomo Corporation [2016] EWHC 1909 concerned the sale of a company holding licence interests in two North Sea oil and gas fields (Ross and Blake). Idemitsu, the buyer, claimed damages for misrepresentation against Sumitomo, the seller.
Hybrid representations and warranties?
Pursuant to a sale and purchase agreement of November 2009 (the "SPA"), Idemitsu had paid Sumitomo US$ 575 million for the company. Idemitsu alleged that certain matters that Sumitomo had warranted in the SPA then turned out to be untrue. The difficulty for Idemitsu was that under the SPA, all claims for breach of warranty had to be notified within 18 months. Idemitsu had missed that deadline, and it was common ground that all claims for breach of warranty under the SPA were, therefore, barred.
Idemitsu instead claimed on a different basis. Idemitsu argued that all the matters that were warranted in the SPA were also, independently, pre-contractual representations. It went on to state that these statements had induced it to enter into the contract. Idemitsu claimed that, since these representations were false (as Sumitomo knew), it was entitled to damages for misrepresentation. On that approach, the maximum that Idemitsu could claim was the amount paid for the company - US$ 575 million. Most importantly, however, misrepresentation claims would not be caught by the contractual time-bar in the SPA.
In Idemitsu, the High Court found that the statements that were warranted in the SPA did not also take effect as pre-contractual representations. In so concluding, the High Court refused to follow another conflicting first instance decision which had found that warranties were also effective as representations - but that hybrid nature is now seriously to be questioned. In this article, we consider these decisions - starting first with an overview of the underlying legal principles.
"Caveat emptor"
At common law, the general rule is, of course, 'caveat emptor' - buyer beware. This applies when purchasing a car for U$ 5,000 as much as it does when purchasing a company for US$ 500 million. Simply by acquiring the company, Idemitsu had not 'purchased' (as the judge put it) the benefit of any promises by Sumitomo about the state of the company, its assets, liabilities, profitability or ability to carry out business. That is why sale and purchase agreements generally include warranties. But a buyer may acquire some protection outside of the contract, in tort, if the seller makes any actionable representations before the contract is entered into.
Representations - liability for false statements
In English law, there are three types of misrepresentation, depending on the state of knowledge of the person making the statement: fraudulent, negligent and innocent misrepresentation. All these require a false statement of present fact, or as to a belief or an opinion held by the person making the statement. The law in this area is partly governed by statute, in the form of the Misrepresentation Act 1967.
At common law, the tort of deceit applies to fraudulent statements. Deceit (or 'civil fraud') does not require any dishonest motive. In Eco 3 Capital Ltd v Ludsin Overseas Ltd [2013] EWCA Civ 413, the Court of Appeal confirmed that an intention to deceive is not a prerequisite of the tort of deceit. As regards the mental state of the defendant, it is sufficient that they (i) either know that the statement is false, or are reckless as to whether it is true or false, and (ii) intend that the claimant should rely or act on the basis of the statement. As was noted in the famous case of Derry v Peek:
"... if fraud be proved, the motive of the person guilty of it is immaterial. It matters not that there was no intention to cheat or injure the person to whom the statement was made."
Short of fraud, claims for negligent misrepresentation are often framed under Section 2(1) of the Misrepresentation Act 1967, because of a reversal of the burden of proof that gives claimants an advantage. If the statement in question is in fact shown to be false, then it is for the person who made the statement to prove that they had reasonable grounds for believing that it was true. In Howard Marine and Dredging Co Ltd v A Ogden & Sons (Excavations) Ltd [1977] EWCA Civ 3, the Court of Appeal described the effect of the 1967 Act as follows:
"In the course of negotiations leading to a contract the statute imposes an absolute obligation not to state facts which the representor cannot prove he had reasonable ground to believe."
While English law allows the parties to negotiations to keep their cards very close to their chest, without imposing any duty to disclose matters to the counterparty (outside the realm of insurance contracts), it does require the parties to say only things that they could reasonably believe to be correct.
Damages for misrepresentation
A claimant can recover damages both for fraudulent and negligent misrepresentation. There is no difference in the measure of damages that can be awarded for a true fraudulent misrepresentation, and a negligent one under Section 2(1) of the Misrepresentation Act 1967. The tortious measure applies, and seeks to put the claimant in the position they would have been in if they had not entered into the contract. So, where the buyer is induced to enter into a share purchase agreement by fraudulent or negligent misrepresentation, damages will reflect the difference between the consideration paid for the shares, and their true value on completion. Both in claims for fraud and under Section 2(1), the claimant benefits from the ordinary rules of remoteness or foreseeability of damages not applying (with the Misrepresentation Act 1967 applying the so-called fiction of fraud to negligent misstatements when it comes to assessing damages).
In Smith New Court Securities Limited v Scrimgeour Vickers (Asset Management) Limited [1996] 4 All ER 769), the sellers' misrepresentations led to an inflated price being agreed by one of several competing buyers. Sometime after the acquisition, the value of the buyer's shares plummeted further due to an unconnected fraud for which the sellers were blameless. The buyer then sold the shares, and sought to claim the difference between the proceeds of the resale (further diminished by the second fraud) and what it had originally paid for it. The House of Lords confirmed that the buyer was entitled to damages for all the losses that it had suffered as a consequence of having been induced to enter into the transaction by the sellers' misrepresentations, whether such consequences were foreseeable or not. Damages therefore included the full reduction in the value of the shares, plus wasted expenses that the buyer had incurred as a result of the contract and its aftermath.
Even an innocent misrepresentation that leads a party to enter into a contract has legal consequences. One important remedy for misrepresentation, in addition to damages, is rescission - an equitable remedy that is discussed further below. Innocent misrepresentations still give rise to a right to rescind the contract for the other party, though they do not normally create a liability for damages.
Rescission for misrepresentation
Suppose the prospective buyer of a car is keen to ensure that it is brand new. The seller confirms that this is the case, and that the car has never been involved in an accident. If that proves untrue, the buyer may wish to unravel the contract, return the car and recover the price paid. This is precisely the result reached in Salt v Stratstone Specialist Ltd [2015] EWCA Civ 745, where rescission was ultimately granted. The buyer commenced proceedings soon after the car began to suffer from a series of defects: he had first sought to reject the car, but the seller was refusing to refund the price. Following disclosure in the litigation, the buyer eventually discovered that the car had not been brand new in the first place. He amended his claim to include misrepresentation, and sought rescission as a way of getting his money back.
At first instance, the Court found that the buyer was not entitled to rescind the agreement, and awarded damages as an alternative remedy. The buyer had paid £21,895 for the car. Damages were assessed at only £3,250, being the difference between what the car would have been worth if it had been brand new, and what it was actually. The Court of Appeal disagreed. Even though four years had passed since the buyer had bought the car, the buyer was not to blame for the delay since he could not reasonably have discovered that the car was not new. Once he had obtained the damning documents in disclosure, he had acted promptly to assert the claim for rescission. There was nothing stopping the car from being returned to the seller, and so the parties were returned to the position they were in prior to the contract.
Rescission is an equitable remedy, and the right to rescind can be lost in a number of ways. Affirming the contract in knowledge of the full facts is one, because the claimant treating the subject matter of the agreement as his own is inconsistent with unravelling the contract. A buyer of shares who, having discovered that the misrepresentation, sells the shares in an attempt to cut his losses is therefore likely permanently to lose the right to rescind - although damages in lieu of rescission could still be awarded. Delay can also preclude rescission. Whereas the buyer in Salt v Stratstone could still rescind the contract four years on, the claimant in a famous case concerning a painting alleged to have been 'by Constable' could not undo the transaction after five years (Leaf v International Galleries [1950] 2 KB 86).
As noted, rescission is an equitable remedy and the Court or arbitrator will have a discretion when deciding whether the passage of time was such that rescission should no longer be granted. In Salt, the Court of Appeal noted that a buyer of art might have been expected to check the painting for authenticity at their earliest convenience, something that was not true in relation to the car. Much will depend on the circumstances of the case in this regard. Finally, rescission will also be denied where it is simply impossible to return the parties to the position they were in before the contract. In case of the acquisition of a business, for example, any prolonged period of the business trading following completion, with new contracts and transactions involving third parties, may well mean that the right to rescission has been lost.
Rescission is the usual remedy for innocent misrepresentation, although Section 2(2) of the Misrepresentation Act 1967 gives the Court or tribunal the power to award damages instead. Importantly, as the Court of Appeal confirmed in Salt v Stratstone, no damages can be awarded for innocent misrepresentation if the right to rescission has been lost.
Warranties
Suppose the buyer of the car did not raise the car's history in the negotiations with the seller. Instead, he instructed a solicitor to draw up a contract for the sale of the car, which required the seller to give a warranty that the car was brand new. The seller, knowing the true condition of the car, enters into the contract in the knowledge that the warranty is breached immediately when he signs the agreement. At this stage, the seller is only liable for breach of warranty, and damages would be assessed based on the difference in value between the car as warranted and in fact as sold. So the buyer in Salt would recover £3,250, but not £21,895.
In corporate acquisitions, the price to be paid for shares can sometimes be calculated by reference to a multiple applied to a base figure, such as profits or revenue over a given period. If that base figure is warranted, but subsequently proves to be incorrect, then damages for diminution in value would usually take account of the multiple applied by the parties. In Lion Nathan Ltd v CC Bottlers [1996] 1 WLR 1438, the price was set as 20 times the forecast profits after tax in a particular accounting period. The sellers had warranted that this forecast had been 'calculated on a proper basis' and 'was achievable based on current trends and performance.' There was a substantial shortfall in profits, and it soon became apparent that the forecast had been unsound. The Privy Council awarded damages by multiplying the difference between the forecast and the actual profits by 20. They noted that:
"... it is quite clear that if this is how the original price is calculated, it is the obvious way to calculate the damages by applying the same multiplier to the shortfall in maintainable earnings/profits."
Damages for breach of warranty are assessed on the contractual basis, intended to put the parties in the position they would have been in had the contract been performed, so that the buyer would have got what he bargained for. That said, damages for breach of warranty may be less advantageous for the claimant than damages for misrepresentations. One reason for this is that, as we have seen, the general rule of foreseeability of loss does not apply in claims of fraudulent misrepresentation (or negligent misrepresentation under the Act). Another advantage of a misrepresentation claim is the prospect of unravelling the deal. If the warranties in the SPA are also statements or representations in the legal sense, then all these advantages may be open to a claimant who can also satisfy the other ingredients of a claim for misrepresentation.
Conflicting approaches
In Invertec Ltd v (1) De Mol Holding BV, (2) Henricus Albertus de Mol [2009] EWHC 2471 (Ch), the claimant entered into a SPA for the entire issued share capital of a company called Volante. One of the defendants, Mr de Mol, had been the sole director of Volante at all material times. Following completion, Invertec found that Volante had significantly greater tax liabilities and outstanding debts to suppliers than had been anticipated. Invertec had to make a series of cash injections into Volante. These additional payments were part of the reason why Invertec subsequently went into administration.
Invertec claimed that it had been induced to buy Volante by a series of fraudulent representations, all of which subsequently became the subject matter of warranties in the SPA. The matters complained of included representations (and subsequent warranties) that Volante's management accounts had been drawn up in good faith, that Volante was able to pay its debts, that its corporation tax liability did not exceed a certain amount shown in a particular tax statement, and that the company was not party to any loss-making agreements.
The High Court found that all but the last matter had been untrue, and that these representations, both prior to and in the SPA itself, had been made dishonestly. Arnold J rejected the argument that because Invertec had secured warranties in the SPA, its only claim was for breach of contract. He noted that the management accounts and the corporation tax statements were information that had been supplied by the defendants prior to the contract. The SPA set out the warranties in a schedule, which also included an express statement that information provided by the seller - including during the negotiations - was true:
"All information contained in Schedules 1 and 2 in this Agreement and (subject as provided below) all information provided by the Vendor and/or the Vendor's Solicitors to the Purchaser's Solicitors in the documents listed in Schedule 8 in the course of the negotiations leading to this Agreement was when given and is at Completion true and accurate in all material respects and the Vendor is not aware of any fact or matter or circumstance not disclosed in writing to the Purchaser which renders any such information untrue, inaccurate or misleading."
Arnold J dismissed the defendants' argument that Invertec's only claim had to be for breach of warranty. He concluded that the relevant warranties were also representations of fact relating to Volante as at the completion date. The warranties had been negotiated over an extended period. The defendants had at first resisted any warranties. Ultimately, they accepted that they would warrant certain matters relating to Volante on completion, but not forward-looking matters. The judge accepted that Invertec was induced to enter into the SPA by the warranties, and that it relied on them. The essential ingredients for a misrepresentation claim - together with the fact that the matters warranted were untrue - were therefore made out:
"In those circumstances I cannot see any reason in principle why Invertec cannot claim that it was induced to [enter] into the agreement by the representations made by those warranties so as to found a misrepresentation claim if they were false, particularly if they were fraudulently made."
Most sale and purchase agreements contain provisions seeking to limit the liability of the parties for pre-contractual statements, and provide that the written contract is the 'entire agreement' between the parties. In Invertec, Clause 19.2 of the SPA was such a clause, stopping short of fraud (liability for which cannot be excluded as a matter of law):
"19.2 Fraud and entire agreement
Each of the parties acknowledge that in entering into this Agreement with the document referred to in it, they do not rely on, and shall have no remedy in respect of, any statement, representation, warranty or understanding of any person other than as expressly stated in this Agreement as a warranty, representation or undertaking. This clause shall not exclude any liability which any party would otherwise have to the other or any right which either of them may have to rescind this Agreement in respect of any statements made fraudulently by the other prior to the execution of this Agreement or any rights which either of them may have in respect of fraudulent concealment by the other."
At first blush, Clause 19.2 may seem intended to limit the parties' liability to claims for breach of contract only, in respect of warranties expressly set out in the SPA. The judge disagreed. The first sentence of the clause gets off to a good start, excluding liability for any "statement" or "representation," but liability is then preserved as regards any "representation" that appears in the SPA. The claimant's misrepresentation claims were not, therefore, caught: the judge found that they related to representation that was incorporated into the SPA as a warranty.
In Sycamore Bidco Ltd v Breslin [2012] EWHC 3443 (Ch), Mann J reached the opposite conclusion. In that case, the buyer asserted that it had been misled by accounts relating to a subsidiary of the company that it had acquired. They relied on relevant warranties set out in the SPA itself, asserting that these also took effect as representations. The judge reviewed the SPA and the disclosure letter, and found instances where the parties had expressly distinguished between 'representations' and 'statements' and 'warranties' so-called. They had gone on to set out a careful regime limiting the seller's liability for breach of warranty, and done so in clauses that made no reference to 'representations' or 'statements'. If each warranty in the SPA were also to take effect as a 'representation,' then the seller would not receive any protection from the clauses limiting liability for breach of warranty that the parties had agreed on - an uncommercial and unlikely outcome.
Finally, the judge noted that there was a conceptual problem because of the timing involved. A misrepresentation claim assumes that a statement is made first, which the other party then relies on when entering into the contract. Where the only statement or representation is said to be in the contract itself, the logic no longer works: the claimant cannot say that it was relying on the clauses in the contract in choosing to enter into the contract. The judge also disagreed that warranties set out in drafts of the contract should be treated differently, even though their content may be factual (giving them perhaps the flavour of a pre-contractual statement or representation). Mann J was of the view that even though the buyer might have 'known what was coming' in the form of warranties, all of which he expected (or hoped) to be true, he would also have known that it was only warranties, but not representations, that were being offered. In Sycamore v Breslin, there could be no doubt on the latter point because the drafting was clear and consistent in stating that warranties were just that.
The decision in Idemitsu
In ordinary parlance, one may think that someone who is 'warranting' something thereby agrees to take on greater responsibility (or liability) than someone who merely 'states' or 'represents' something. As we have seen, however, the legal meaning of these terms has no such connotations. In Idemitsu, the judge explained that:
"When a seller, by the terms of the contract under which he sells, "warrants" something about the subject matter sold, he is making a contractual promise. Nothing less. But also I think (and all things being equal) nothing more. That is so just as much for a warranty as to some then present or past matter of fact as it is for a warranty as to the future. By contracting on terms by which he warrants something, the seller is not purporting to impart information; he is not making a statement to his buyer. He is making a promise, to which he will be held as a matter of contract in the sense that any breach of the warranty will be actionable as a breach of contract, subject to any other relevant terms of the contract and to general principles of the law of contract, for example as to remedies."
The judge gave an example of a seller of grain who warranted that it was free from a particular disease. One would not necessarily have expected the seller to know that for sure, or to have checked (assuming there are large quantities of grain in his warehouse). The warranty given is not, therefore, a statement of fact about the particular merchandise. The Court in Idemitsu also noted the conceptual difficulty with statements (or rather terms) in the contract inducing someone to enter into the contract in the manner required by the law of misrepresentation.
Idemitsu also argued that the seller made the relevant representations by providing the execution copy of the SPA, which contained the warranties - the argument being that this was a statement made prior to the contract, such that the problem with timing and reliance might be overcome. The judge disagreed with that, too. He felt that the schedule containing the warranties in the execution copy could not be divorced from the rest of the SPA. Clause 6.1 of the SPA introduced the warranties, and simply said that "Each of the Sellers warrants to the Buyer ...". Absent further contractual wording, or any references to 'representations,' the warranties were simply that.
What is more, Idemitsu's claim would have been caught by the 'entire agreement' clause in the SPA, which included an acknowledgment that Sumitomo "... has not relied on, or been induced to enter into, this Agreement by any representations, warranties or undertakings of any kind other than the Warranties (as modified by the Disclosure Letter)." Such non-reliance clauses are effective to exclude a claim for misrepresentation (save for fraud), as the would-be claimant is estopped from alleging that he did, after all, enter into the agreement in reliance on a representation.
Conclusion
Idemitsu preserves the possibility that something said in the course of negotiations, or something set out in a draft contract, can in appropriate circumstances amount to a representation, and so give rise to liability in tort if it is false. The SPA did not, however, contain anything which could have suggested that the parties intended the warranties to take effect as representations as well. The drafting was careful and consistent on that point. Without further support in the contract wording, and absent any specific factual statements by the sellers during the negotiations, the misrepresentation claim had no realistic prospects of success. What is more, the all-important 'non-reliance' statement in the SPA provided an additional, and insurmountable, obstacle.
Finally, the author accepts no liability if the distinction between representations and warranties remains unclear.
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.
