Introduction to representations, warranties and indemnities under English law and practice

18 February 2013

Presentation to the Supreme Commercial Court of the Russian Federation

2

Basic legal principles under English law

• Caveat Emptor – no implied warranty as to the state of the company/assets/shares being sold

• The seller has no duty of disclosure to the buyer (but it cannot use fraud to induce the buyer to enter into the contract – Taylor v Hamer)

• Very limited statutory protection for a buyer of shares - FSMA

• No “pacta sunt servanda” rule and no duty to negotiate in good faith (and even a contractual agreement to negotiate in good faith is unlikely to be enforceable – Walford v Miles)

• Representations, warranties and indemnities are therefore commonly used to apportion risk between the buyer and the seller

3

Key distinctions between warranties, indemnities and representations

• Warranties are given in the contract and are the most common protection for a buyer

• Indemnities are given in the contract and usually protect against identified potential issues

• Representations can be both in or outside the contract

• Differences largely relate to the ease of bringing a claim and the potential recovery

4

Warranties: general

• A warranty is a contractual statement of fact. It is a term of the contract

• “The Company is not engaged in any litigation or arbitration proceedings”

• If a warranty is breached, the buyer is entitled to bring a claim for breach of contract

Warranties may be absolute or given subject to the knowledge of the Warrantors:

“so far as the Warrantors are aware, the target company has in the last 3 years complied with all applicable laws”

5

Warranties: general

• Warranties are usually qualified by a Disclosure Letter. To the extent a matter is deemed disclosed in accordance with the SPA no claim can be brought

“The Company is currently the subject of arbitration proceedings in respect of its contract with ABC Ltd, in the amount of £750,000”

• Warranties provide dual benefits to a buyer

– price adjustment

– encourage the seller to disclose

• Repetition of warranties

• The remedy for breach of warranty is monetary damages for loss of value in the shares purchased

6

Warranties: requirements to bring a damages claim

• Four principal requirements to bring a successful damages claim

– breach of warranty

– the buyer must demonstrate it has suffered a loss of value in its shares

– the loss must have been caused by the breach of warranty

– the loss must not be too remote

• A loss will not be too remote if

– it flows naturally from the breach, or

– the loss could have been reasonably contemplated by the parties as a result of the breach (Hadley v Baxendale)

• Buyer has a duty to mitigate its loss

7

Warranties: quantum of damages

• Contractual measure of damages applies

• Court will seek to put the buyer in the position as if the contract had been performed

• Compensates buyer for expectation interest/loss of bargain (i.e. the difference between the market value of what the buyer was expecting to acquire and the market value of what it did acquire)

• Buyer’s valuation method is, therefore, relevant

• Distinction between the loss in value of the shares and the loss in value of the company

8

Warranties: effect of disclosure and buyer’s knowledge

• Courts will uphold contractual standards with regards to disclosure

– “fairly disclosed”?

– “fully, fairly and specifically disclosed”?

• Warranties may be ineffective if the buyer has actual knowledge of breach (Eurocopy)

• However, the buyer may attempt to contractually reserve its right to sue in respect of a breach of Warranty even where it had knowledge of the breach. Recent case law suggests that courts may uphold such provisions (Infiniteland)

9

Warranties: Limitations on Liability

• Time limits (contractual or statutory, e.g. Limitation Act 1980)

• Financial limits

– individual claim de minimis

– threshold

– aggregate cap

• Other

– no double recovery

– conduct of claims

– notice provisions

– contingent claims

• No limitations for fraud

10

Indemnities: general• Contractual undertaking to pay for loss incurred upon the occurrence of a

specified event

• A claim under an indemnity is enforcing a contractual right, not a claim for breach of contract

• Gives rise to a debt claim (as opposed to a damages claim in the case of a breach of warranty)

• Not subject to disclosure

• Overrides ordinary damages – “Pound for pound” recovery - therefore, the buyer’s valuation is not

relevant as is the case when assessing damages for breach of warranty– Loss and mitigation principles do not apply

• Indemnities are typically used:– where there is a known issue/risk (since a warranty claim would be

unlikely to succeed due to buyer’s knowledge)– where the seller has agreed to give warranties “on an indemnity basis” –

this is unusual in UK transactions (with the exception of tax)– in respect of tax, pensions and environmental liabilities

11

Representations: general

• The law of misrepresentation derives from statute (principally the Misrepresentation Act 1967) and common law

• A representation is a statement of fact which may or may not be expressly set out in the contract, although sellers will seek to limit their liability for any exposure beyond the contract by including “entire agreement” clauses (often combined with “non-reliance” statements)

• If the representation is false, then the buyer may have a claim for misrepresentation, provided that:

– the representation was a statement of fact (rather than a statement of opinion) – RBS v Chandra, and

– the buyer relied on the representation when deciding to enter into the contract

12

Representations: remedies and quantum of damages• Two principal remedies for misrepresentation: rescission and damages

• Three types of misrepresentation: innocent, negligent and fraudulent

Type of misrepresentation

Available remedies Quantum of damages

Innocent • Rescission (primary remedy)

• Damages (only in lieu of rescission at the court’s discretion)

Special remedies calculated under s. 2(2) of the Misrepresentation Act 1967

Negligent • Rescission (subject to

s. 2(2) of the Misrepresentation Act 1967)

• Damages

Tort damages (designed to put the claimant back in the position it was in before the tort occurred), including all direct losses

Fraudulent • Rescission

• Damages

Tort damages, including consequential loss with no foreseeability requirement

13

Representations: remedy of rescission• Rescission is a remedy that enables a contract to be set aside and seeks to

put the parties back into the position in which they were before the contract was made

• Can be contrasted with termination of a contract for breach of condition as termination results in the parties being released from their future obligations but not any accrued obligations, whereas rescission results in the contract being set aside and treated as if it had never existed

• The right to rescind the contract may be lost in the following circumstances:

– Affirmation of the contract: the buyer must not act in a manner which is inconsistent with the decision to rescind the contract (Long v Lloyd)

– When the return to the original position is impossible: this is a question of fact; “substantial” restitution is sufficient (Armstrong v Jackson)

– Lapse of time: in the case of fraudulent misrepresentation, the time runs from the time the fraud was discovered; for other types of misrepresentation, the time runs from the date of the contract

– Third party rights: if a bona fide purchaser for value acquires an interest in the property, the right to rescind would be lost (Phillips v Brooks)

• In practice it is often excluded as a remedy in a sale and purchase agreement

14

ContactsContacts

Mokhovaya Business Center Stroenie 2, 4/5 Vozdvizhenka StreetMoscow 125009 Russia

Nik KutnaksAssociate

T: +7 495 956 3858   E-mail: nkutnaks@debevoise.com