on Wednesday, 16 February 2022.
Caveat Emptor allows for the buyer to ask the right questions about the company being acquired, in order to obtain as much information as possible before completion. The buyer will also typically require the seller to give certain warranties in respect of the company to obtain further protection.
Warranties are contractual statements given by the seller regarding the affairs of the company being sold. These are usually drafted in the purchase agreement and can cover a wide range of areas - for example, employment, tax, intellectual property, data protection compliance and ownership of assets. Warranties are therefore important in order to provide the buyer with a remedy for any undisclosed risk. If a seller gives a warranty but it is later discovered that the warranty was untrue as at the time it was given, the buyer may have a claim in damages against the seller.
As part of the negotiation process, the seller will either confirm the warranties are true or provide disclosures against the warranties (usually via a formal "disclosure letter") of any matters that would render the warranties untrue. For example, if a warranty states that there are no employment disputes but there is in fact an ongoing grievance raised by an employee, the seller would be well advised to provide full details of that matter to the buyer (using the disclosure letter) and, provided the criteria set out in the purchase agreement for satisfactory disclosure are met, the buyer will be prevented from bringing a claim against the seller in respect of that particular matter.
Dependent on the wording in the purchase agreement, it is often the case that a buyer will not be prevented from bringing a claim in respect of a matter of which it has knowledge: in such a case only matters that are formally disclosed by the seller in the disclosure letter will limit the seller's liability under the warranties.
The buyer purchased the entire share capital of an energy company. The seller gave a warranty that the energy company's plant and equipment was in good repair and condition, in accordance with its environmental permit. Unfortunately, following completion, it became apparent that there was a fault with the company's plant and machinery, which led to a client contract being terminated. As a consequence, the buyer bought a claim against the seller for a breach of warranty, arguing that the plant and equipment was not in good repair, as warranted by the seller.
The seller, however, argued the buyer had actual knowledge of the issue with the plant and equipment, and therefore the warranty could not be relied upon.
The High Court ruled in favour of the buyer. The Court found that the seller was liable for the breach of warranty and awarded the buyer damages of £11 million.
The Court confirmed the environmental permit had in fact been breached by the seller, and therefore the buyer was entitled to claim for breach of warranty. The Court added that the plant and equipment was performing poorly in the months leading up to completion.
The seller should have therefore made a disclosure against the warranty. The seller was aware, prior to completion of the sale, that the plant and equipment was not capable of performing in accordance with the agreed contracts in place. The Court highlighted that the seller was unable to establish any specific disclosure against the warranty in question.
This case emphasises the importance of a seller making disclosures in a formal manner rather than relying on the buyer's knowledge about the target company.