A large proportion of SPA warranty or indemnity claims under W&I policies over the last 10 years have not been claims under the general warranties, they have been claims under the tax indemnities or tax covenants. In this article, we comment on issues arising in claims for tax losses under SPAs and W&I policies and focus on one of the issues the subject of the Court of Appeal decision in Minera, namely claiming losses under the SPA tax indemnity for contingent tax losses.
Minera v Glencore
The Glencore group of companies (the "Seller") sold a Peruvian company (the "Company") to the Claimant, Minera Las Bambas SA ("Minera"). The Company constructed and operated copper mines in Peru. After the sale, Minera faced claims from the Peruvian Tax Authority (the "PTA") for unpaid VAT. The PTA sought to deduct the unpaid VAT in question from the Company's accumulated VAT credit balance and the Company appealed to the Peruvian tax court. Although the Company would not have to make an actual payment in respect of the unpaid VAT until that appeal was determined (and it expected to win on appeal), notwithstanding, Minera brought a claim against the Seller under the tax indemnity in the SPA to place it in funds and indemnify it in respect of its contingent liability.
Under the tax indemnity, the SPA only allowed a claim for losses to be brought in respect of tax liabilities which were "payable". It became clear during argument before the English Court that under Peruvian tax law, the Company was not liable to pay anything to the PTA until after any related tax appeal was determined. Under Peruvian law, tax is not "payable" in circumstances where there is an outstanding appeal.
As the Court of Appeal noted, "the word 'payable' is not a legal term of art; it is a word which is capable of bearing different meanings in different contexts". In this context, "payable" meant when there was an enforceable obligation to pay an amount of tax, not merely a liability to pay tax. Further, treating the Sellers' obligation to pay an amount of money to Minera as triggered in such a situation was inconsistent with the general nature and purpose of an indemnity.
The Court of Appeal also found that where, as here, there was only a contingent liability to pay tax, there was nothing stopping Minera notifying a claim under the SPA within the SPA's seven year limitation period and bringing proceedings to establish its right to be indemnified in respect of an amount of tax which may become "payable". Although there was a clause in the SPA explicitly granting Minera a right to serve notice of a claim in respect of any contingent liability, the Court did not feel it had to rely upon that clause in making this finding but did so on general principles.
It is notable that, by taking the approach it did, Minera also potentially incurred higher tax penalties as a result. Had Minera paid the penalties and interest prior to lodging an appeal to the Tax Court, it would have qualified for a 60% discount instead of the 40% discount that it received after the appeal was lodged.
Commentary: Setting appropriate strategy
The decision in this case emphasises the need for a purchaser to consider carefully the wording of the indemnities in the SPA and adopt an appropriate strategy to minimise the potential liability and to ensure that rights of indemnity from the seller are protected. The case of Minera v Glencore is an interesting example of the hazards of dealing simultaneously with the tax authority and a claim under the SPA. The case ended up at the Court of Appeal with the lead judge giving the parties the strong steer that they had come to commercial litigation too soon.
Under English law, subject to anything to the contrary in the SPA, it is possible to serve Notice of Claim under an SPA in respect of contingent tax liabilities. Bearing that in mind, and also with a view to avoiding the high cost of pursuing litigation, it is often sensible to wait for a tax liability to crystallise, or for HMRC to clarify its position before bringing claims under the tax indemnities. Under SPAs, a purchaser commonly has seven years to serve Notice of a Claim under SPA tax indemnities, tax warranties, and/or tax covenant.
Claiming its contingent tax liabilities prematurely, combined with an apparent misunderstanding as to how the tax penalty system works in Peru, would have cost Minera considerable sums in terms of legal costs and exposed it potentially to significantly enhanced tax penalties. There were no doubt reasons for bringing the claim which do not appear from the reported judgments and likewise for the decision to make payment of tax penalties and interest after, rather than before, an appeal to the Peruvian Tax Court. However, with hindsight, it looks as though Minera would have been better advised, and would have avoided time consuming and expensive litigation, had it stayed its hand and not sought to claim losses for tax liabilities which remained contingent on the outcome of an appeal to the Tax Court.
The reason why such a large number of W&I claims are for tax losses is we suggest partly because, once liabilities are established by HMRC, the level of indemnity payable is also established. Challenging HMRC's assessment of tax payable is an uphill struggle with the tribunals taking a very pro-HMRC attitude especially when they perceive tax avoidance. Contrast this with claiming for loss for breach of one of the general warranties in an SPA, where both breach and quantum may be contested.
Claims under tax indemnities is a long game. HMRC can take more than the standard seven years for notification of a claim under the SPA to determine the unpaid tax and it may be necessary before the end of the limitation period to serve notice and bring proceedings to establish a purchaser's right to be indemnified before the tax has actually become "payable".
Dealing with the tax authority
Unlike most parties to litigation, tax authorities often have unlimited resources, extremely impressive legislative powers and may take litigation on a point of principle. We find the types of errors leading to claims under SPA tax indemnities commonly fall into two categories: (a) errors which have arisen because of the complexity of accounting principles and/or the tax code; and (b) where the sellers were tempted by what we would now call aggressive tax planning.
It depends on what the tax error was, and there may be good reasons to sit back and wait for the tax authority to make the first move, but (and this is certainly our experience with HMRC in the UK) it can sometimes be a good idea to go on the front foot and not wait to see how they will progress their investigations.
Penalties should be a real consideration when deciding how much to engage with the tax authority. In the UK, penalties can easily come to 50% or more of the tax to be paid and with the right approach towards settling past tax liabilities these can fall dramatically. There are set ranges for the penalties but going to HMRC rather than waiting to be approached and responding to HMRC's enquiries rather than appearing to hide information should bring you to the bottom of the appropriate range (although if the tax error was deliberate rather than careless, you will never get the penalty below 20%). This is one of those areas where being nice to your creditor certainly pays off.
Notification under the SPA and when to pull the trigger
Defects in notification type defences frequently appear in SPA disputes and ensuring full compliance with the Notice requirements under the SPA is absolutely vital. Such defences are often technical and may not necessarily have obvious merit but must be anticipated and avoided.
Once a Notice of Claim is served upon the seller under the tax indemnity, a dispute may quickly arise and, subject to the terms of the SPA, quick progression to arbitration or litigation may be inevitable. The decision in Minera v Glencore illustrates the dangers in taking this step under the SPA prematurely, when things are still up in the air with the tax authorities and liability remains contingent. We advise notifying early and in strict compliance with the Notice clause to preserve rights under the SPA, but to consider carefully the appropriate timing of bringing a claim.
Under W&I policies the rule of thumb is to notify early, in detail, and to involve your insurers in the process of investigating the liability and negotiating with the tax authority. Where W&I insurance is in place, insurers will want to be part of a process. W&I insurers and their own advisors are likely to be experienced in liaising with HMRC and may add significant benefit (and savings) to the process. Of course, bringing insurers in early and co-operating fully may also inform the amount ultimately paid under the policy.
The process of claiming under a W&I policy is likely to be a very different prospect to pursuing a claim against an antagonised or hostile seller. Depending upon the error which has led to unpaid tax, sellers are often motivated to defend past management decisions and to deny liability. W&I insurers carry no such baggage with them and, save where there is fraud involved, their focus when assessing the loss claimable under tax indemnities is usually on quantum, which under a tax indemnity is likely to be self-determining: it is what HMRC determine is payable. In our experience, W&I insurers determine cover without strict regard to the sort of defences which would be deployed by defendants to civil litigation. This point of difference illustrates the value of W&I policies to the M&A market and insureds should involve their insurers early when potential tax liabilities are identified.
To read more on SPA notification requirements, see our article on the case of Cardamon v MacAlister here.
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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.