Mind the gap: indemnity provisions and pre-completion loss

We take a look at a recent High Court decision and its implications for drafting indemnities in sale agreements. Is the wording 'prior to Completion' sufficient?

01 May 2020

Buyer Beware!

In the recent High Court decision in Gwynt Y Mor Ofto PLC v Gwynt Y Mor Offshore Wind Farm Ltd & Ors [2020] EWHC 850 (Comms) the court examined the construction of an indemnity allocating risk between the parties for damage caused prior to completion.

In this case, the buyer had purchased a company that owned and operated the connection between a wind farm and the national grid, which included four subsea cables. After completion, two of the subsea cables failed. The failure resulted from serious corrosion most likely having been caused by damage to the polyethylene sheath during the manufacture of the cable which would allow seawater to penetrate and erode the cable. The buyer incurred significant costs to repair the damage.

The SPA contained the following indemnity: 'If any of the Assets are destroyed or damaged prior to Completion (Pre-Completion Damage), then, following Completion, the [sellers] shall indemnify the [buyer] against the full cost of reinstatement of any Assets affected by Pre-Completion Damage.'

In reaching its decision the court addressed two key questions. First, what period was covered by the indemnity; and second what type of damage did it cover amongst a number of other ancillary issues. In this article we focus on the two key questions.

Timing

First, Philips LJ examined the phrase 'prior to Completion'.  He stated that the SPA must be interpreted as at the date it comes into force i.e. as at signing. Looking at the specific wording of the indemnity here the use of “are” was crucial as when interpreted from the date of signing, this therefore referred to damage or destruction caused in the gap period between signing and completion only and not, as the buyer argued, to damage caused at any point prior to completion i.e. during the seller’s ownership. Had the parties intended the longer period to be covered, they could have included specific wording to this effect e.g. 'including prior to this Agreement'.

The court also looked at the indemnity in the wider context of the SPA. The indemnity could be found in the provisions relating to signing and ahead of those relating to completion. In this context, it could reasonably be interpreted as a risk allocation mechanism to address the fact that during the gap period the buyer, having signed the SPA, will be bound to buy the business but ownership and control would not yet have passed.

Looking at the indemnity in the context of other provisions in the SPA. Here there was a warranty about the absence of damage to the assets as at the date of signing to which the various limitations in the limitation schedule applied. If the indemnity was to be widely interpreted this would render this warranty and the associated protections in the limitations schedule redundant and this could not have been the intention of the parties. Therefore the indemnity was limited to damage caused during the gap period.

Damage

In examining the wording 'destroyed or damaged' the court held that whilst there was no scope for confining this to new damage caused during the gap period it did require the damage to be patent. The requirement for the damage to be readily observable or discoverable stemmed from the fact that 'damage' followed 'destroyed' and therefore required damage short of destruction.

The court again contrasted the choice of wording of the indemnity to that of the negotiated warranties which included the wording 'defect or damage' and as such the latter was intended to provide protection against a wider range of damage than the indemnity.

Finally, the court looked at the practical implications if the indemnity covered latent defects and found that this could mean sellers being liable for failures which resulted years after completion and which have been caused, in part, by continuing damage post-completion which the court felt was absurd particularly where the gap period (i.e. the time period the indemnity was found to apply to) was short.

Lessons learned

This case highlights the importance of precise drafting in sales documentation and the parties having a clear understanding of exactly how risk has been allocated between them.

Whilst it remains to be seen if this case will be appealed, it’s a timely reminder to double check the drafting in sales documentation to ensure that any risk allocation mechanisms clearly cover the risks you intend them to.

How can we help?

If you would like to discuss this briefing please speak to your usual contact at Burges Salmon or Nick Graves.

Key contact

Nick Graves

Nick Graves Partner

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