Drafting Warranties and Disclosure Provisions: A Reminder of the Importance of Clear Provisions
A recent English High Court case has highlighted issues that should be considered when negotiating warranties in a share or asset purchase agreement. In relation to whether a time bar applied for the buyers bringing a warranty claim, the case considered whether the buyers were able to do so given that they knew about the breach relevant to the warranty even though the relevant disclosure was not set out in the disclosure letter.
Facts and Background
The recent case Butcher & Anor v Pike & Ors  EWHC 3432 (QB) concerned the sale of the entire issued share capital of BPG (UK) Limited (Company) by two individual sellers (Sellers) to three individual buyers (Buyers).
The Company was a lettings agency providing services to residential landlords. In order to provide this service, the Company had 'Residential Lettings Membership' with online property platforms such as Rightmove. The terms and conditions with one of the platforms potentially prohibited the Company from placing adverts on behalf of other lettings agents on the platforms (Restriction).
The share purchase agreement (SPA) contained a number of standard warranties in relation to the condition of the Company and its business. Warranties provide a buyer with a potential remedy where the warranty is untrue or misleading. In this case, the Sellers warranted that 'The Company has not defaulted under any agreement or arrangement to which it is a party'. The Sellers had disclosed the Restriction but had not stated in the disclosure letter that the Company was in breach of it.
Sellers often seek to limit their potential liability under warranties in an SPA. Two common ways of doing this are by (i) setting time limits for when breach of warranty claims can be notified by a buyer and (ii) by specifying that no claim can be made for matters disclosed in the disclosure letter. Disclosure is the process by which a seller can qualify the warranties given, such that if a warranty is untrue, a buyer only has a claim for breach of warranty if the facts giving rise to the claim were not disclosed to the buyer. The relevant limitations on liability contained in the SPA in this case were that:
- 'the Warranties [were] subject only to any matter which [was] fully, fairly and specifically disclosed in the Disclosure Letter'; and
- 'no claim for breach of the Warranties, [...], shall be made unless the claim has been notified in writing to the Warrantors within 6 months of the Completion Date'.
The effect of these clauses was that if a matter was specifically disclosed in the disclosure letter, then the Buyers would be unable to bring a warranty claim against the Sellers, but if there was a claim it had to be made within six months of completion. There was a carve out to the six-month time limit however, in situations 'where there [had] been fraud or negligent non-disclosure'.
Here, the Buyers knew of the Restriction, but the Company's breach of it was not disclosed in the disclosure letter and the Buyers brought a warranty claim outside of the six-month limit.
The Buyers claimed that they were not informed by the Sellers in the disclosure letter that the Company was in breach of the Restriction, nor were they informed of the extent of the breach. Accordingly, the Buyers claimed that the Sellers were in breach of warranty.
The Sellers response was that they were not in breach of the Restriction on the basis that there was no contractually effective Restriction and therefore they were not in breach of the warranty.
The Buyers also asserted that the time limit of six months did not apply, as there had been a 'negligent non-disclosure' under the SPA. They argued that, as the warranties were expressed to be 'subject only to matters fully, fairly disclosed in the disclosure letter', any disclosure had to be set out in the disclosure letter. Consequently, as the breach of the Restriction was not included in the disclosure letter, there was a negligent non-disclosure.
The Sellers in turn argued that the Restriction did not need to be included in the disclosure letter, and as the Buyers had actual knowledge of the terms and conditions of the platforms and the business, there had been a disclosure.
The court decided in favour of the Sellers. The judge construed the wording of the SPA in such a way that there should be a difference between disclosure to qualify warranties and disclosure to determine whether the six-month time limit applied.
The purpose of the disclosure letter was for the Sellers to state which warranties are untrue and to provide sufficient detail to enable the Buyers to be aware of the facts that qualify the warranties. The purpose of the carve out for fraud or negligent non-disclosure was to allow the Buyers to bring a late claim if the facts necessary to bring such a claim were concealed by, and ought to have been disclosed by, the Sellers. As the Buyers did actually know about the Restriction, albeit not through the disclosure letter, the time limit of six months should be applied.
Although the Company was found not to be in breach of the Restriction, the issues that arose from the ambiguity in the SPA merit consideration. It was unclear what was meant by disclosure in relation to the time limit and it was unclear as to the position where the Buyers knew of the facts but they were not disclosed in the prescribed way, namely in the disclosure letter.
The issue of whether a buyer's knowledge of facts, derived from sources other than the disclosure letter, can limit a seller's liability has been considered by the courts in the leading cases of Eurocopy v Teesdale  and Infiniteland v Artisan . In Eurocopy, the Court of Appeal suggested that a buyer may not be able to claim for breach of warranty if he had actual knowledge of the facts or circumstances not disclosed by the sellers, despite a clause in the share purchase agreement stating that he should not be prejudiced by any knowledge. This suggestion was mentioned at an interlocutory heading and as the case settled before proceeding to a full hearing, there was no judgement issued.
The later case of Infiniteland casts uncertainty on whether a court may allow a buyer to claim for a known breach of warranty. The High Court, in obiter comments, rejected the seller's argument that the buyer should not be able to claim for breach of warranty where there was knowledge of the breach, regardless of any provision in the share purchase agreement concerning the buyer's knowledge. The Court of Appeal found that there was no breach of warranty and there had been valid disclosure.
The High Court and Court of Appeal found different reasons to deny the buyer the right to recover where the buyer's team knew of the facts. Lord Justice Chadwick who handed down the leading judgment in the Court of Appeal suggested that the effectiveness of a knowledge saving provision depends on the precise wording of the agreement, and in obiter comments referred to the Eurocopy case when considering the provision on actual knowledge of the buyer, without suggesting that Eurocopy had been wrongly decided.
In light of Eurocopy and Infiniteland, it is considered that a buyer's actual awareness of facts at the time of entering into an acquisition agreement may be a defence for a seller, an arguable one at least, against a buyer's claims for breach of warranty. Consequently, the acquisition agreement must set out clearly the agreed position and the extent to which a buyer's knowledge qualifies the warranties.
When negotiating disclosure provisions particular attention should be paid to the following:
- Standard of disclosure. The threshold to effectively qualify the warranties, known as the standard of disclosure, should be made clear and be understood by the parties. This then leaves less room for disputes in assessing whether there has been a disclosure or not. In Infiniteland the Court of Appeal stated that in assessing if disclosure had been made and was effective the court would look at the express terms of the acquisition agreement and, in such cases, there is no objective standard of disclosure. A seller would usually set the standard as fair while a buyer may seek a higher level, for example of full, fair and specific. The common negotiated position is that disclosure must be fair and there must be a sufficient level of detail included so that the disclosure can be understood by a buyer.
- Knowledge of the buyer. Whether a warranty claim can be brought if the buyer had actual or imputed knowledge, or whether warranties are subject only to the disclosure letter, should be expressly stated in the SPA. A buyer will want to make it clear that only items included in the disclosure letter are disclosed despite any knowledge that the buyer may have. Including such a proviso in a SPA is not common in the UK but a clause to this effect, named a sandbagging clause, is popular in the US. A seller, on the other hand, may want to include an express term that anything a buyer has actual or imputed knowledge of is deemed to be disclosed. If a seller strongly resists, a buyer may consider how to limit the meaning of knowledge of the buyer, for example by including a provision stating that knowledge of a buyer means the actual knowledge of named individuals only. It is common practice for a buyer to insist that the acquisition agreement includes a provision that any knowledge imputed to a buyer, in addition to actual and constructive knowledge, does not prejudice its ability to bring a warranty claim.
- Warranty and indemnity insurance. If there is an insurance policy the parties should familiarise themselves with the terms of the policy and the level of cover. The level of cover will differ between a buy-side policy and a sell-side policy. A standard buy-side policy will generally only cover issues that are not known after the due diligence exercise and will exclude matters actually known about. A buy-side policy often includes a requirement for a no claims declaration where specific individuals from a buyer's team sign stating that they do not have any knowledge of a matter which may render an insured warranty untrue. Coverage of known issues may be covered specifically in a policy with specific sub-limits, or by a separate policy. Sell-side policies are generally less flexible, as they reflect the liability in the acquisition agreement agreed by a seller. This again highlights the importance of precise drafting to reflect the agreed position between the parties to the acquisition.
*Emma Elliston contributed to this Advisory.
© Arnold & Porter Kaye Scholer LLP 2021 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.