05 December 2014

Businessmen who insist on warranties in sale agreements may not know the limitations on the protections they are getting. Buyers use warranties to protect themselves against problems emerging after sale. The seller is invariably in a better position to know about these problems than the buyer. Consequently, sellers are commonly required to offer warranties (promises) about the business. If those promises subsequently turn out to be wrong the buyer might expect to be repaid the amount they have lost. If so they would be wrong.

The High Court in Bir Holdings v Balraj Mehta has confirmed the existing approach to calculating the amount to be paid for breaches of warranty. Compensation is calculated according to the diminution in a business’ value that has arisen as a consequence of the breach. This is the value of the company if the warranty was true less the value with the warranty breached.

The key point is that a breach of warranty which causes a direct loss of profit or future income etc., will probably not result in a reduction in value of the company or not as much as that actual loss. Companies are valued in terms of goodwill and, future and past earnings etc. These valuation methods may not be significantly affected by the particular breach even though the sum of money lost can be exactly ascertained.

Buyers who rely upon warranties should be aware that the amount they may reclaim will probably not relate directly to the actual income they have foregone as a result of the breach. The Bir Holdings case is an example.

In Bir Holdings, the Seller of a company issued restitution proceedings against the Buyer, who – under the terms of a share purchase agreement – had arranged for funds to be released from a retention fund on account of the Seller’s alleged breach of warranties. The Court was tasked with valuing the Buyer's claims, in order to determine the extent of restitution required.  

Upholding the approach adopted by the instructed expert, Judge Cooke confirmed that damages must be assessed according to the diminution in the value of: i) the business as warrantied; and ii) the business as actually acquired. This embeds existing case law, confirming that the purpose of damages is not to reimburse the Buyer of his direct financial loss per se (this falls within the remit of indemnities).

It was deemed reasonable for an expert to value the ‘business as warrantied’ in line with the purchase price, this being a fair reflection of its worth in those circumstances. Likewise, where the breach of warranty is an undisclosed fact, it is legitimate to consider the likely implications of disclosure on parties’ negotiations at the time in order to assess the value of the ‘business as actually acquired’. However, the Court rejected the Seller’s argument that information available since the date of sale – namely the Buyer’s lack of financial loss arising from the breach – should be considered. It held that hindsight will only be relevant in exceptional circumstances.  

The author Cate Brown is a member of Burges Salmon's Dispute Resolution team led by David Hall.

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David Hall

David Hall Partner

  • Dispute Resolution
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