A corporate financier might say that only a fool or a liar would find themselves on the receiving end of a breach of warranty claim after the sale of a business.
Arguably, a well-organised, properly advised vendor should be able to sell a business and be reasonably certain that a claim from the purchaser will not follow. But forensic accountants see plenty of cases where a breach of warranty is alleged and a claim is made.
Some of these claims arise due to completing deals in a hurry, or where the commercial desire to 'do a deal' has overridden the need to properly secure both parties' positions through the transaction documentation. Purchasers who choose to claim generally come across a number of stumbling blocks, some of which we consider here.
Damages
The measure of damages in a breach of warranty case will be the difference between the value of the business sold as warranted and its actual value.
It is often assumed that the value of a business sold as warranted is equivalent to the consideration paid. However, sometimes the warranted information supports a lower valuation than the consideration paid. The purchaser may have paid more for a number of reasons, such as their own projections of what the company could achieve in the future.
Understanding what valuation the warranted information would have supported should be the starting point to assess the damages that the purchaser could credibly recover.
Bases of valuation
Arguments over how a business was valued when it was acquired are likely to become central to quantifying potential damages. This was highlighted in Senate Electrical Wholesalers Ltd v Alcatel Submarine Networks Ltd [1999]. The claimant pursued damages in excess of £26m but the Court of Appeal awarded none, even though the court found for a material breach of warranty following an overstatement of profits reported in warranted management accounts.
This decision should serve as a reminder that the eventual outcome of a breach of warranty case may be a finding of a breach, but no loss. An unattractive prospect considering the time and expense involved in bringing such an action.
The claimant's own accounts – having it both ways?
When one company purchases another, the directors of the acquiring company may perceive, after the event, that what they bought is not worth what they paid. But how do they disclose this information in their accounts?
Accounting standards dictate that the identified loss should be recognised in the acquiring company's audited financial statements. But this suggests to their audience, including the company's investors and the financial markets, that the directors made an error of judgment and bought an overpriced company.
The directors can only be vindicated if they pursue a claim for breach of warranty successfully and secure damages to compensate for their perceived overpayment.
This tension can lead claimants to try and have it both ways; they claim for the acquired business being worth less than warranted, but do not reflect this in their accounts. Particulars of claim in a breach of warranty case can therefore be completely at odds with the treatment of the transaction in the claimant's own audited financial statements.
This arose in Senate, where the claimant made what was described as a "massive" claim, but the audited financial statements indicated only a "modest" loss. The Court of Appeal commented: "...it hardly lies in the mouths of the directors or auditors of Senate to say that the accounts were wrong having regard to their statutory duties..."
One of the first courses of action for a defendant in a breach of warranty case should be to examine the financial statements of the acquiring company to see if they can identify such an obvious conflict with the particulars of claim.
Warranties over accounts
A variety of warranties may have been given on the results reported in the audited financial statements and management accounts of the company being sold. A number of these may turn out to be problematic for the warrantor when a claim is brought against them.
For example, giving a warranty that includes the word 'accurate' in relation to accounts is likely to leave the vendor exposed. This term is fundamentally incompatible with the basis on which accounts are prepared, which involve judgment rather than the absolute precision that the word 'accurate' implies.
Furthermore, giving warranties over management accounts can be dangerous for vendors, unless the management accounts in question are really of the standard that the warranty implies.
As this article highlights, claims for breach of warranty may not be as cut and dried as some claimants think.
Breach of Warranty
In-house seminar for lawyers
Smith & Williamson's Forensic Services team has had extensive experience of acting as experts and advising on claims for breach of warranty, both for claimants and defendants.
Using this experience we have developed an in-house seminar suitable for lawyers:
- engaged in advising on the sale and purchase of businesses and companies
- instructed by claimants and defendants in breach of warranty cases.
Our seminar covers:
- relevant case law
- the principles of calculating damages in breach of warranty cases
- valuation issues
- issues arising from examples of actual warranties
- how best to enhance the chances of a successful claim for breach of warranty how best to defend a claim for breach of warranty.
This seminar typically runs for one hour, and is CPD-accredited with the Law Society and ILEX. It can be provided to groups of six or more (including contentious and non-contentious lawyers), free of charge, at your offices or at a location convenient to you.
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.
