In any private M&A transaction, the availability and scope of seller warranties is invariably an important consideration for the buyer. That is because, aside from due diligence, warranties represent the key mechanism for buyers to protect themselves against the risk of the assets changing hands being worth less than originally believed.
However, the number of warranty claims passing through the English courts in the past few years would suggest their frequency is on the rise.
There are a number of possible reasons. First, it is likely the general surge in M&A activity in recent times is partly responsible. Second, in a fiercely competitive deal environment driven by a glut of excess capital or 'dry powder', it may be that, post-completion, buyers are more willing to explore opportunities by which extra value can be unlocked from acquisitions.
A third factor could be the increasing popularity of Warranty & Indemnity (W&I) insurance, which some buyers see as an easier route by which to secure a recovery for breaches of warranty. The purpose of this product, which has been particularly prevalent in private equity deals, is to transfer the majority of the financial risk associated with future breach of warranty claims from the seller into the commercial insurance market.
If recent cases are anything to go by, it is likely that breach of warranty disputes will continue to be fought on two key battlegrounds. The first battleground, seen time and again, concerns observance of the procedural requirements for notifying and bringing claims, which sale and purchase agreements (SPAs) and other transaction documents typically prescribe.
While this type of argument is technical and therefore less likely to succeed without clear non-compliance, the potential 'knock-out' consequences they offer means that defences based on procedural breaches will continue to be raised.
One such recent example is Ipsos S.A. v Dentsu Aegis Network Limited, where a notice from the buyer was found not to meet the formal requirements for a “Claim Notice” under the SPA.
Similar arguments are also made in relation to price adjustment and indemnity disputes, where the contractual machinery for making price adjustments or bringing indemnity claims is also typically the subject of procedural steps.
The second battleground is valuation, where the measure of loss is generally accepted to be the difference between the value of the shares as warranted and their true value.
However, determining what a willing buyer would have paid to a willing seller in the absence of a market is not straightforward. The approach tends to vary from case to case.
For example, expert evidence is commonly required and the factual question of what the buyer would have done, if fully aware of the position, is frequently contentious (Sycamore Bidco Limited v Breslin & Anor). A related question that has come to prominence in the past year or so has been the extent to which a buyer's losses can be capped in light of matters arising after the breach of warranty (in other words, whether a company can be valued in hindsight, with the benefit of knowledge acquired after the date of breach).
For the time being, the answer according to Ageas (UK) Limited v Kwik-Fit (GB) Limited & Anor and Bir Holdings Ltd v Mehta would seem to be that the circumstances in which this can happen are limited.
The incidence of claims other than those centred on warranties also seems to be rising. The operation of pricing mechanisms in SPAs continues to be a common source of dispute and claims under indemnities have also been addressed on a number of occasions.
Again, it may just be that in a climate in which demand is high for a limited number of quality targets, this trend is part and parcel of the same willingness to look for other sources of value after transactions have completed. While W&I insurance can go some way to addressing this issue, the prevalence of private M&A disputes in general is clearly a development that is of particular concern for the private equity sector. ?