DISPUTE RESOLUTION UPDATE
The recent case of Teoco v Aircom Jersey has emphasised the need for buyers to take particular care when giving notice to sellers of a warranty claim under a share purchase agreement ("SPA").
By way of background, it is usual for a buyer to require the seller to provide promises or 'warranties' in the SPA regarding the condition of the target company.
Warranties generally serve two key purposes:
- They complement the due diligence process by flushing out any potential problems with the target
- They provide the buyer with a remedy (a claim for breach of warranty) in the event that one or more of the warranties turn out to be untrue.
The SPA will usually set out a specific procedure that the buyer must follow when notifying the seller of a breach of warranty, including, for example, the precise method by which claims should be communicated, and any deadlines for doing so.
As was the case in Teoco, if the buyer does not comply with the procedure set out in the SPA, it may lose the ability to claim damages for breach of warranty from the seller.
The Court of Appeal's decision in Teoco
The buyer, Teoco, bought the entire issued share capital of the target company, Aircom International Limited ("Aircom"). The seller provided Teoco with various warranties about the condition of Aircom, one of which was that neither it nor its subsidiaries were subject to any existing tax claims or disputes.
The SPA provided that, in order to pursue a breach of warranty, Teoco must give written notice to the seller of any claim for breach of warranty, including reasonable details of the claim and the grounds on which the claim was based. Otherwise, the seller would not be liable for breach of warranty.
After the purchase of Aircom had completed, Teoco discovered that, contrary to the seller's warranties, Aircom had tax liabilities of approximately £3.45 million in respect of its subsidiaries in Brazil and the Philippines. Teoco's solicitors subsequently sent two letters to the seller purporting to notify it of the claim.
However, the seller disputed liability for breach of warranty on the basis that it claimed that the notification procedure in the SPA had not been properly followed. In particular, it said that the letters sent by Teoco's solicitors were ambiguous, in that they referred to “tax exposures [which] may exist”, “potential…tax liabilities” and the “estimate of…possible quantum”. Most importantly, they did not identify the specific warranties contained in the SPA which were alleged to have been breached.
Teoco subsequently issued court proceedings for breach of warranty. At first instance, the High Court found in the seller's favour, striking out Teoco's claim on the basis that the letters did not comply with the specific notification requirements in the SPA and were insufficiently detailed.
The Court of Appeal unanimously upheld the High Court's decision. It held that:
- Both letters sent by Teoco's solicitors failed to satisfy the requirements in the SPA, because they did not identify the particular warranties on which the claims were based.
- Setting out the grounds of a claim means that the legal basis of the claim has to be identified. This generally requires explicit reference to particular warranties or other provisions.
Ultimately, each case will turn on its facts, including the wording of the relevant contractual requirements. However, the case is a useful reminder of the need for buyers to ensure that notice of a claim for breach of warranty strictly conforms to the notification requirements in the SPA.
Buyers may be tempted to 'hedge their bets' and draft notifications in broad terms so as to keep their options open in respect of the claim being made, but this is a risky strategy. If the notice does not comply with the notification requirements in full, and explicitly refer to the specific warranty that is alleged to have been breached, the claim is at risk of being rejected and the seller may escape liability altogether.
It's also good practice for buyers to make sure that, where circumstances permit, they allow sufficient time to deal with any issues that may arise in respect of the notification before the deadline for giving notice passes. As was the case here, there is unlikely to be any chance of rectifying a mistake in the notification procedure later on.
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