Case Review: The Importance Of Warranties In A Share Purchase Agreement

A recent High Court case involving an insurance company has reinforced how important warranties are in a share purchase agreement and why they should be considered in detail before entering into the agreement.

In 116 Cardamon Limited v MacAlister and Another [2019] the Court held that the sellers were in breach of an accounting warranty due to the accounts underproviding for the company’s liabilities. The Court awarded £2,386,247.50.

A share purchase agreement is the key document in a share sale. It sets out the terms of the deal and there are certain provisions which can be crucial to this agreement including warranties.

Further reading: Corporate Spotlight: A guide to the Share Purchase Agreement

Warranties in Share Purchase Agreements

A warranty is a contractual statement of fact. In the context of a share purchase agreement, warranties are given by the seller about different aspects of the target company as at completion of the sale. If a warranty proves to be untrue then the buyer may be able to claim damages based on breach causing the value of the shares to be worth less than their warranted value (i.e. that the shares have diminished in value).

Therefore, warranties are a key buyer protection and often the subject of negotiation between solicitors to try and reach a fair position between their clients. A seller’s solicitor may attempt to include financial limitations on claims for breach of warranty and time limitations specifying a cut-off date for the buyer to bring a claim.

116 Cardamon Limited v MacAlister and Another [2019]

In Cardamon the target company was Motorplus Limited, an insurance company which sold “add-on” insurance policies for motor and household insurance such as legal expenses cover and lost key insurance.

This was a unique case in which the company was sold to the buyer for £2,386,247.50, which was considered to be at a discount as the sellers needed a quick sale without the buyer undertaking due diligence. There was a £500,000 claims threshold (under which claims would be irrecoverable) and there was a claims cap at the amount of the purchase price.

The dispute centred around the company’s accounts for the financial year ending 31st August 2013. The sellers warranted the truth, fairness, accuracy and proper preparation of these accounts. Despite what was reflected in the year-end accounts and subsequent management accounts, it was alleged that Motorplus was effectively insolvent at completion.

The buyer brought three warranty claims against the sellers. One claim was dismissed on the basis of being Disclosed by the sellers and another claim was dismissed on the basis the buyer’s notice of claim didn’t substantiate the basis of their claim (i.e. it didn’t correctly refer to a warranty clause).

However, the claim in respect of the underprovision of liabilities in the year-end accounts was successful. This related to a specific scheme under which Motorplus accepted responsibility for paying claims under before-the-event legal expenses insurance. There was a provision in the accounts for the company’s liabilities for this scheme but the judge found that it had been significantly underprovided for.

Calculating the loss to the buyer, however, proved difficult due to the previous years’ accounts also having an underprovision (i.e. the starting point for the provision was wrong) and as the judge considered the warranted value of the shares was higher than the purchase price due to the sale being at a discount. Ultimately the buyer was awarded £2,386,247.50, the purchase price liability cap, for the breach of warranty as it was concluded that the value of its loss exceeded the purchase price by more than £500,000.

The case highlights:

• that warranties should not be considered lightly by sellers;
• that buyers should not overlook the importance of a thorough due diligence exercise (in this case this may have flagged the accounting discrepancies prior to the completing the deal); and
• the need to carefully consider and draft claim limitation clauses.

Further reading: 6 Key Steps to Selling Your Business

For more information on share purchase agreements or on selling your business, please contact BHW’s corporate team on 0116 289 7000 or email info@bhwsolicitors.com.