Warranties: Commercial intention

Author: Sam Tye

The Court of Appeal judgment in Belfairs Management Ltd v Sutherland and another (Belfairs) looked at the interpretation of warranties given in connection with the sale of shares in a company.

On a sale of shares a seller will commonly be asked to give warranties, which are essentially a set of confirmations as to the nature and state of the business of the company to which the shares relate. To the extent that a warranty is not true, the seller will have an opportunity to disclose that fact prior to the sale of the shares in a disclosure letter to the buyer. Provided that a disclosure against a warranty is in sufficient detail and fair, generally speaking, it will prevent a buyer from bringing a claim against the seller for breach of warranty in respect of the matter disclosed.

Matthew and Christine Sutherland (Sellers) were formerly the owners of the issued shares of Waveform Solutions Ltd (Waveform). By a purchase agreement completed in February 2008 (SPA), Belfairs Management Limited (BML) purchased 60% of their shares for £2m. Following the acquisition Waveform entered into administration in November 2008 and creditors’ voluntary liquidation on 24 February 2009. Following the liquidation of Waveform, BML brought a claim against the Sellers for breach of the following warranty:

"The Company is not a party to any agreement, arrangement or commitment which cannot readily be fulfilled or performed by it on time."

The basis for the claim was that a key motivation for the acquisition by BML of the shares in Waveform was the proposed award of a contract to it by the NHS (NHS Framework Agreement). The NHS Framework Agreement would, subject to Waveform meeting criteria set out in the agreement, give Waveform the opportunity, as part of a restricted market, to bid for contracts with the NHS primary care trusts, being contracts which had the potential for yielding considerable returns. The NHS Framework Agreement had not been signed by the time of completion of the SPA in February 2008 because Waveform required the capital injection which would be provided as a consequence of the transactions effected pursuant to the SPA to enable it to enter into the NHS Framework Agreement.

It was common ground as between BML and the Sellers that the opportunity represented by the NHS Framework Agreement was at the heart of the deal negotiated with BML. There was also no issue that both sides approached the signing and completion of the SPA on the assumption that, as happened, Waveform would then promptly sign the NHS Framework Agreement. Indeed the disclosure letter from the Sellers to BML specifically referred to the NHS Framework Agreement in certain of its disclosures against warranties given in the SPA (but not in a manner which would prevent a claim for breach of the warranty referred to above). The disclosure letter therefore assumed that the (as yet unsigned) NHS Framework Agreement was an "agreement, arrangement or commitment". A central commercial reason for the acquisition was the opportunity that the NHS Framework Agreement would give Waveform to bid for contracts from the primary care trusts, an opportunity that was, however, dependent on Waveform attaining Level 2 status under the NHS contract within 12 months, which, as it turned out, Waveform was unable to attain.

The questions that the court was required to determine in assessing BML’s claim were: "(i) was the NHS Framework Agreement an "agreement, arrangement or commitment" within the meaning of paragraph 16.1 of Schedule 3; if yes, (ii) what was the nature of the para 16.1.5 warranty; and (iii) was the warranty breached?"

The court determined that the NHS Framework Agreement was an "agreement, arrangement or commitment" because it was clearly a fundamental part of the commercial rationale for BML’s acquisition of part of the share capital of BML. The court further noted (although did not take into account the fact in reaching its decision) that BML and the Sellers had themselves viewed the NHS Framework Agreement as an "agreement, arrangement or commitment" until counsel for the Sellers late in the trial made an argument that the NHS Framework Agreement should not be considered as such. The court therefore concluded that the warranty was given in respect of the NHS Framework Agreement (even though it had not been entered into at the date of the sale). It was clear that Waveform was not able to fulfil or perform it on time and the warranty was therefore breached. The court found in favour of BML.

It is apparent from the decision in Belfairs that the court was prepared to reject the literal reading of a warranty in a share purchase agreement, which had been the common position adopted by the English courts, and instead take into account the commercial intention of the parties. This marks a departure from the English courts’ previous position of reluctance to determine the commercial intention of the parties to an agreement. The consequences of this change in position are yet to manifest themselves but it is clear that legal counsel acting for sellers of shares who are giving warranties to a buyer will need to ensure that their client is aware of the continuing need to undertake a full and thorough disclosure exercise. Warranties given by sellers should be carefully drafted to ensure that a lack of clarity does not give the courts an opportunity to incorrectly imply its interpretation of the parties’ commercial intentions.

In many respects the decision in Belfairs can be seen to turn on the facts of the case where a significant, possibly the most significant, commercial driver for BML was the NHS Framework Agreement. It was understood by both parties that the agreement would be entered into after the SPA was completed but also that the SPA would not be entered into at all if the NHS Framework Agreement would not be signed. In the majority of share sales these set of facts will not be replicated and Belfairs is therefore unlikely to have any direct impact in determining the scope of any particular warranty.

If, however, there is an agreement which is unsigned but which is in near agreed form or which is to be entered into shortly after completion of the share sale agreement and the existence of that agreement is an important commercial driver for a share acquisition, the seller should assume that any warranty could be deemed to relate to that agreement. The disclosure letter should be drafted on the presumption that a court, having regard to the commercial circumstances, might be prepared to read the warranties in the context of the commercial intention of the parties rather than by taking a literal interpretation of the agreement.

Sam Tye, Solicitor, Fladgate LLP (stye@fladgate.com)

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