It’s about what you know
When it comes to buying and selling companies, the seller often starts with the upper hand. Because the seller already owns the company, it usually knows much more about the business than the buyer, and is in a much better position to know the company’s true value. So when the price is agreed in principle, the seller typically has a better idea than the buyer of whether it’s a good deal.
From a buyer’s perspective, the main job of the purchase agreement is to try and redress this imbalance in information. The main way in which this is done is by requiring the seller to give a number of warranties about the company and its business. If these warranties turn out to be untrue or misleading, the buyer may be able to claim damages from the seller. In this way, the buyer can be compensated if the company turns out not to be worth as much as the buyer paid for it.
As such, and unsurprisingly, the warranties (and how they can be enforced) are often one of the most heavily negotiated aspects of any company acquisition. If disputes do arise in relation to these types of deals, the question of whether the seller is liable under a warranty claim often hinges on the specific wording of the agreement.
A recent case in the High Court (MDW Holdings Ltd v Norvill & others  EWHC 1135 (Ch)) helped to reiterate some of the key issues that can arise during this type of dispute.
In 2015, MDW Holdings Ltd (“MDW”) paid over £3.5m to purchase 100% of the shares in GD Environmental Services Ltd (the “Target Company”). The Target Company’s business involved waste management and so it was subject to numerous environmental regulations. The purchase agreement therefore contained a number of warranties about the Target Company’s compliance with those regulations. In reality, the Target Company had repeatedly and seriously breached the regulations. It would have cost a significant amount for the Target Company to meet its regulatory obligations and so, by failing to comply with them, it was artificially boosting its profitability. When MDW discovered this, it argued that it had paid much more than the Target Company’s true value.
One way for a seller to avoid liability under a warranty claim is to disclose details of the relevant breach (or other issue) to the buyer before the sale is completed. In order to get off the hook in this way, a seller would need to provide fair and adequate information to the buyer and also comply with any specific requirements of the purchase agreement regarding the disclosure of information.
In the MDW case, the court found that the sellers had not properly disclosed the most serious breaches of the relevant environmental regulations or sufficient details of their history. As such, the sellers could not rely on disclosure as a defence to MDW’s breach of warranty claim.
The sellers also argued that MDW knew about the Target Company’s breaches before the purchase. The judge gave this argument short shrift – although MDW knew there had been some one-off breaches of the regulations, it did not know about some of the most serious breaches, including that the Target Company had repeatedly and deliberately given false data to the relevant regulator.
Purchase agreements usually provide that warranty claims are time-barred if they are not notified to the seller(s) within a certain period after completion. In this case, the purchase agreement required claims to be notified before 14 October 2017. However, the agreement also stipulated that this time limit would not apply in the event of dishonesty, fraud, wilful misconduct or wilful concealment by the sellers. The judge found that the Target Company’s breaches of warranty involved dishonesty and wilful concealment, so the sellers failed with their argument that MDW had missed the deadline.
Entire agreement clause
Most commercial agreements include an ‘entire agreement’ clause which aims to limit the legally-binding agreement between the parties to the matters specifically set out in the document. However, if these clauses are not well drafted, a party may still be able to rely on pre-contract statements made by the other party. This was the case here, and so MDW was entitled to claim damages for misrepresentation on the basis of false statements made by the sellers before the deal was done.
In view of the above, the sellers were ordered by the Court to pay damages to MDW reflective of the difference between the purchase price paid and the true value of the Target Company.