UK COURT RELIES ON EXTRANEOUS CIRCUMSTANCES TO DETERMINE THE SCOPE OF A WARRANTY IN A SPA
Courts in India or in other jurisdictions such as the UK commonly interpret a contract based on a plain and simple reading of the clauses. Occasionally, in instances where a simple construction of the contract leads to ambiguous or commercially unreasonable results, courts endeavor to ascertain the actual intention of the parties at the time of signing of the contract. Such an exercise to ascertain the commercial intention of the parties is carried out by reading the contract as a whole. Courts rarely attempt to ascertain the commercial intent of the parties by relying on external factors such as surrounding circumstances at the time of signing of the contract, communication prior or at signing of the contract etc.
In one such rare instance the UK Court of Appeals in Belfairs Management Limited v. Matthew Sutherland & Ors.1relied on the surrounding circumstances at the time of signing of an acquisition agreement to determine the scope of a warranty clause.
Waveform Solution Limited ("Waveform") which was a supplier of communications and information technology decided to bid for a government tender which invited suppliers to participate in a programme to modernize the computer systems across UK's National Health Service ("NHS Programme"). The NHS Programme was seen by Waveform and many other market players as an extremely profitable venture. The NHS Programme required the tenderers to fulfill certain minimum eligibility requirements before they could be awarded the principal agreement ("Framework Agreement"). The Framework Agreement allowed the suppliers to supply required systems to the end users after certain milestones were achieved over a period of time. However, the Framework Agreement did not guarantee any specific number of assured sales.
The implementation of the Framework Agreement required significant capital expenditure to be made upfront. Thus, Matthew and his wife Christie Sunderland ("Sellers") who were the promoters of Waveform decided to arrange for a deal that would re-capitalize Waveform. In light of this the Sellers entered into a share purchase agreement ("SPA") with Belfairs Management Limited ("Acquirer") whereby the Acquirer acquired a 60 per cent stake in Waveform. The Sellers used the cash generated from the deal to inject funds into Waveform by way of a shareholder loan.
Following the acquisition, a dispute arose between the Sellers and the Acquirer when Waveform failed to implement the Framework Agreement resulting in an enormous loss of revenue. In fact, since Waveform had invested substantial capital and manpower for the implementation of the Framework Agreement, it had to close down its other businesses. The failure to implement the Framework Agreement led to Waveform being unable to pay dues of its creditors (other than the Sellers or the Acquirer). As a result, the creditors filed for dissolution of Waveform.
Simultaneously, the Acquirer also sued the Sellers for breach of warranty and deceit. The Acquirer's case was primarily based on a breach of warranty under the SPA wherein the Sellers had represented and warranted that "the company is not a party to any agreement, arrangement or commitment which cannot be readily fulfilled or performed by it on time" (the "Warranty Clause"). Relying on the Warranty Clause the Acquirer argued that the Sellers had breached the Warranty Clause by not providing the Acquirer an objective assessment regarding Waveform's ability to implement the Framework Agreement at the time of acquisition.
The Sellers on the contrary argued that the Framework Agreement which was not signed at the time when the SPA was consummated could not be brought within the scope of the term "agreement", "arrangement" or "commitment" in the Warranty Clause.
FINDINGS OF THE TRIAL COURT
Based on the arguments advanced by both the parties, the trial court framed three issues for determination of the claims of the parties: (i) whether the Framework Agreement was an "agreement, arrangement or commitment" under the Warranty Clause?; if yes (ii) what was the scope and nature of the warranty set out in the Warranty Clause?; and (iii) was the Warranty Clause breached by the Sellers?
On issue (i) the trial court ruled in favor of the Sellers on the ground that as on the date of the consummation of the SPA, the Framework Agreement was not signed by Waveform and thus could not be an "agreement, arrangement or commitment" under the terms of the SPA and hence was not covered by the Warranty Clause. On issue (ii) the trial court found that in the event the Framework Agreement formed an "agreement, arrangement or commitment" to which the Warranty Clause applied, the Sellers were only required to provide a subjective assessment of whether the Framework Agreement could have been performed by Waveform. Based on its findings in respect of issues (i) and (ii), the court found that there was no breach of the Warranty Clause.
FINDINGS OF THE COURT OF APPEALS
On issue (i) the Court of Appeals held that the Framework Agreement formed an "agreement, arrangement or commitment" under the terms of the SPA and hence was covered by the Warranty Clause. The Court of Appeals relied on the evidence from the negotiation between the parties and presentations made by the Sellers in respect of the financial projections of Waveform to the Acquirers. The Court of Appeals specifically relied on: (a) the initial communication between the Sellers and the Acquirer wherein the Sellers represented that the Framework Agreement had 'enormous potential' and as a result of which the Sellers were willing to retain some portion of their shareholding in Waveform; (b) the executive summary of the financial projections of Waveform shared by the Sellers with the Acquirer which made a specific reference to the Framework Agreement; (c) the cover email sharing the executive summary with the Acquirer's attorney which made specific reference to the Framework Agreement and its inestimable potential; and (d) the financial due diligence report carried out by the Acquirer's adviser stating that the projection of Waveform's future earnings and current value would be highly dependent on the implementation of the Framework Agreement. The other factor that influenced the Court of Appeals to arrive at this finding was the fact that the Sellers themselves had conceded in the initial stages of the litigation that the Framework Agreement constituted an essential element of the transaction.
On issue (ii) the Court of Appeals found that the Seller was required to make an objective assessment of whether the Framework Agreement could have been implemented. In other words, the Sellers were required to make a reasonable commercial judgment regarding Waveform's ability to perform the Framework Agreement and disclose it to the Acquirer.
Since issue (iii) required a finding of fact, the Court of Appeal remanded the matter back to the trial court.
The judgment may become relevant to acquisitions involving India as considering the limited case law on the interpretation of representations and warranties in India, the courts in India tend to rely on English law judgments in commercial matters. Also, in most cross-border acquisitions, parties tend to prefer to be governed by English law.
In light of this judgment, parties involved in an acquisition should be mindful of the following-:
1  EWCA Civ 185
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