Warranties are crucial in share purchase agreements

24th July 2019

A recent case in the English High Court has once again highlighted the importance of warranties in share purchase agreements and why they should be considered carefully before the deal is done, particularly if the sale is a quick one.

In this case, the purchaser was 116 Cardamon Limited and they were buying Motorplus Limited, an insurance company that sold additional insurance policies to complement motor and household insurance, like cover for legal expenses.

Speed was only part of the problem

The sale was negotiated quickly and concluded in May 2014. The speed of the sale caused a few issues, with the buyer not undertaking the usual due diligence because the Motorplus management team were considering a buy-out and Cardamon wanted to avoid showing their hand too early.

The original asking price by the sellers was £5M, but the sale was agreed at a discounted price of around £2.4M, as the sellers wanted a quick sale.

Unusually, there was a claims threshold on the sellers’ liabilities, which rendered the first £500k of any claim non-recoverable, with a claims cap at the agreed purchase price.

The sellers also offered the warranties without first undertaking a detailed disclosure exercise to identify any exceptions. This decision was at the heart of the dispute, which centred on the accounts for the complete financial year ending prior to the 2014 sale.

The sellers warranted that these accounts were fair and accurate, despite them and subsequent management accounts showing, it was alleged, that Motorplus was effectively insolvent at the time the deal was completed.

Warranties in Share Purchase Agreements

A share purchase agreement (SPA) is the key document in a share sale and sets out the terms of the deal. It details the provisions that are crucial to the agreement and includes any warranties.

A warranty explained

A warranty is a contractual statement of fact and in a share purchase agreement, is presented by the seller to describe different features of the business at the point the purchase is completed.

If a warranty is found to be wrong, the buyer may be able to claim damages for a breach of the warranty in question, which may have caused the shares to be worth less than their warranted value.

This is why warranties are an essential protection for the buyer and typically the subject of intense negotiation between the solicitors of both parties to try and reach a position fair to buyer and seller.

A seller’s solicitor is likely to try to include limitations on the size of claims for a warranty breach, with a cut-off date for the buyer to bring any claim.

In this deal, the SPA contained warranties about the content and preparation of Motorplus’ statutory accounts. One of the warranties specified the statutory accounts did not understate any liabilities, adequately provided for bad debts and were prepared according to acceptable accounting standards.

After the deal was completed, Cardamon discovered inaccuracies in the accounts. Its auditors recommended restating the accounts for 2013 which caused the Buyer to allege that Motorplus was insolvent when acquired.

This ensured the Buyer brought three warranty claims against the sellers:

  • an underprovision in the accounts
  • a failure to write off a debt
  • a failure to disclose a change in remuneration practices for insurance brokers

The two claims, concerning the debt and the remuneration changes were dismissed, but the claim concerning the underprovision was upheld.

In breach of a warranty

It was discovered the accounts only made provision for claims up to August 2013 and not for those received up to the mutually agreed date of February 2014. The Court found this significant underprovision in the accounts did in fact put the sellers in breach of warranty.

The Court calculated the likely damages caused by the error were in excess of £2.8M, but the seller’s liability under the SPA capped the damages to the final discounted sale price. The Court duly awarded the amount of the purchase price and entitled Cardamon to recover the full £2.4M they paid for Motorplus.

Consider your warranties carefully

This case highlights the need to take seriously the warranties and disclosures that form an essential part of the sale of a business. And what can go wrong if you do not give the topic due consideration.

The seller failed to undertake a proper disclosure exercise, which resulted in them warranting inaccurate accounting matters they did not properly understand. An oversight so important, they have ended up effectively giving their business away for nothing.

Finally, remember that warranties should not be considered lightly, buyers should undertake a thorough due diligence exercise regardless of how quick a deal is expected and claim limitation clauses need to be considered in detail and drafted by experienced lawyers.

If you are considering buying or selling a business or if you would like more information on share purchase agreements, please speak to Emma Benniston in our Corporate & Commercial team. Contact her on 0121 716 3701 or to hear how we make it happen.