In the first instalment of our blog series on warranty claims, we look at the recent decision of the Court of Appeal in Dodika Ltd v United Luck Group Holdings Ltd. The case considered what needs to be included in a notice of claim for a breach of a warranty contained in a Share Purchase Agreement (SPA).
1. What is a warranty?
A warranty is a contractual statement as to the condition or state of affairs of a company or business being acquired at a particular point in time. The seller gives warranties to the buyer.
For example, the seller might give a warranty that it is not aware of any current or pending litigation against the company being sold. This would be an important assurance for a buyer.
The granting of a warranty means that if the statement turns out to be untrue, the buyer will have recourse against the seller.
For a more detailed discussion of the difference between warranties and indemnities, and what needs to be proven for a breach of warranty claim to succeed, see our earlier blog.
2. What happens when a warranty is breached?
If a warranty has been breached, a buyer can make a claim for damages against the seller. To do so, the buyer must prove that the warranty was untrue when given and that the breach caused a reduction in the value of the company at that time.
If a seller believes that a particular warranty has been breached, they need to notify the seller. This notification is called a 'Notice of Claim'. The SPA will set out the form of the Notice, the content to be included and any deadline for issuing the Notice. The content would ordinarily relate to specification of the buyers knowledge of the circumstances giving rise to the claim.
3. Dodika Ltd v United Luck Group Holdings Ltd
In Dodika Ltd v United Luck Group Holdings Ltd, the Court of Appeal overturned a High Court decision and allowed a notice of claim which did not include a statement of the amount being claimed or much detail.
In December 2016, United Luck purchased shares in a company which developed mobile game applications for $1bn from Dodika Ltd. The SPA included a tax covenant under which the sellers agreed to pay an amount equal to any tax liability arising from an event which occurred or profits earned before the sale.
The SPA required the buyer to give written notice to the seller stating "in reasonable detail" various things including "the matter which gives rise to such Claim" by 1 July 2019. In July 2018 the Tax Authority in Slovenia commenced an investigation into the Slovene subsidiary of the company. Both the buyer and seller's representatives were kept fully informed of the investigation.
A week before the deadline of 1 July 2019, before the tax investigation concluded, the buyer's solicitor gave written notice to the seller of a claim under the tax covenant. The seller argued that this notification failed to include the "reasonable details" required under the Agreement, including the sum claimed. The High Court agreed with this argument and granted summary judgment in favour of the seller, dismissing the buyer's claim.
The buyer then appealed to the Court of Appeal, on the basis that the High Court had erred in concluding that a reasonable recipient of the notice would say it did not know the details of the claim. The buyer argued that a reasonable recipient, with the knowledge of the tax investigation which the seller had, would have known exactly what the letter was referring to.
4. The Court's decision
The Court of Appeal agreed the with the buyer's argument for the following reasons:
- The judges agreed that a notice which did not comply with the SPA would be invalid, even if the seller already knew about the matter in question. However, they also felt that information conveyed by a notice was informed by the background context, including any knowledge which the seller in fact had. In this case the seller had already been aware of the detail of the tax authority's investigation.
- There was very little specific detail available to the buyer, including the amount of the tax liability, as the investigation was ongoing.
- The notice had to be read in the context of the commercial purpose of the requirements in the SPA. The purpose was to enable the seller to make enquiries into the factual circumstances of the claim (so far as possible) to assess its merits. Setting out further "limited and generic detail" or repeating facts of which the seller was already aware served no commercial purpose.
5. Key takeaways
The decision of the Court of Appeal serves as a reminder to sellers of the importance of providing accurate responses throughout the due diligence process and subsequent disclosure exercise. Failure to do so could lead to a claim for breach of warranty after the sale has completed.
The decision helpfully demonstrates that the courts will take a common sense approach when determining whether a buyer's notice contains sufficient information to meet the requirements of the SPA. Nonetheless, it remains important that any buyer making a claim for breach of warranty observes the notice requirements set out in the SPA and provides as much detail of the claim as is reasonably possible, as the Court of Appeal might have put it, "in all the circumstances".
If you are considering circumstances similar to those in this commentary, please get in touch with your regular Brodies contact or one of the contacts listed below.