In this article we discuss the guidance provided on the
interpretation of no ‘Material Adverse Change’ warranties,
‘Knowledge’ exceptions and ‘Valuation’.
The Commercial Court has recently handed down a decision
involving the review of a no ‘Material Adverse Change’ or
‘MAC’ warranty given in a share purchase agreement that was
backed by Warranty & Indemnity (W&I) insurance. In reaching
its decision, in the case of Finsbury Food Group Plc v Axis Corporate
Capital UK Ltd [2023] EWHC 1559 (Comm) (26 June 2023), the
court examined both the scope of the warranty given and what the
parties meant by a material change – as well as providing
guidance on issues of knowledge, causation and valuation
Background
Finsbury Food Group (Finsbury) is a group of food manufacturing
companies, including various bakery businesses. In recent years,
there has been an increased demand for gluten free (GF) and other
‘free from’ baked goods and Finsbury had been looking for
options to expand its business into those areas. Ultrapharm Limited
(Ultrapharm) was an own-label manufacturer of GF
speciality bread and bakery products, whose primary business was
the supply of GF goods to customers in the UK.
Following a period of negotiation, Finsbury purchased Ultrapharm in
accordance with the terms of a Sale and Purchase Agreement dated 31
August 2018 (the SPA) for £20 million.
Also on 31 August 2018, alongside the SPA, Finsbury
entered into a Buyer-Side Warranty and Indemnity Insurance Policy
(the Policy) with a series of underwriting syndicates (Insurers).
The Policy was taken out by Finsbury as the ‘buyer’, to
give it protection against any loss that may be suffered as a
result of any breach of the warranties given in the
SPA. The Policy did not require Finsbury to sue the
warrantors before a claim could be made; in the event of a breach
of warranty Finsbury could just claim under the Policy (a
relatively common structure for sellers seeking a clean break).
Following completion of the SPA, Finsbury alleged
that Ultrapharm had breached warranties in the SPA
that had been provided by its CEO, resulting in an overall
reduction in the value of Ultrapharm’s business by over
£3 million.
The claim
Finsbury claimed under the Policy, however, Insurers rejected
the claim and Finsbury commenced proceedings.
The warranties
Several contractual warranties were given to Finsbury by the
sellers in relation to Ultrapharm’s business. These
included:
2 CHANGES IN THE ACCOUNTS DATE
2.1 Since the Accounts Date: …
2.1.2 there has been no material adverse change in the
trading position of any of the Group Companies or their financial
position, prospects or turnover and no Group Company has had its
business, profitability or prospects adversely affected by the loss
of any customer representing more than 20% of the total sales of
the Group Companies or by any factor not affecting similar
businesses to a like extent, other than as a result of factors
which have affected businesses in the same industry, in general and
so far as the Warrantor is aware, there are no circumstances which
are likely to give rise to any such effects;
2.1.9 no Group Company has offered or agreed to offer
ongoing price reductions or discounts or allowances on sales of
goods relating to its business or any such reductions, discounts or
allowances that would result in an aggregate reduction in turnover
of more than £100,000 or would otherwise be reasonably
expected to materially effect [sic] the relevant Group
Company’s profitability;
The Accounts Date was 31 December 2017.
Alleged breaches
After completion of the SPA, Finsbury realised that
Ultrapharm had actually agreed with its key customer – before
acquisition – to a change in the recipe for two key products
(the Recipe Change) and to a reduction in the price of those
products on two different occasions (the Price Reductions).
Finsbury alleged that the Recipe Change and the Price Reductions
were MACs and were therefore a breach of warranty
2.1.2. Separately it was alleged that the Price Reductions were a
breach of warranty 2.1.9. As a result, Finsbury claimed that it had
overpaid for the Ultrapharm business by almost £3.1 million
(on the basis of a “warranty true” vs “warranty
false” analysis).
Insurers refused to pay out under the Policy. They did not
accept that there had been a breach of warranty because the changes
had been disclosed to Finsbury before completion. Furthermore,
Insurers alleged that Finsbury would have paid the purchase price
of £20 million in any event, as that was the price the CEO of
Ultrapharm was willing to accept and the amount Finsbury was
willing to pay for the Ultrapharm business.
Commercial court decision
In reaching their decision the Commercial Court considered three
key issues:
- the true construction of the warranties at 2.1.2 and 2.1.9 and
whether the Recipe Change and the Price Change amounted to a
MAC; - whether Finsbury’s knowledge of the Recipe Change and the
Price Change acted as a bar to any recovery; and - even if there had been an actionable breach of warranty,
whether Finsbury would have paid the purchase price in any event
(such that there was no recoverable loss).
The warranties
As with many post-merger and acquisition (M&A) claims, the
breach of warranty issues turned primarily on the construction of
the relevant contractual provisions, demonstrating again the
importance of carefully drafted SPAs and transactional
documentation.
Insurers had argued that clause 2.1.2 required any
MAC to result in the loss of sums representing more
than 20% of the target group’s total sales (i.e. that the 20%
threshold was a fundamental part of the MAC
definition).
However, recognising that there were deficiencies in the
drafting of warranty 2.1.2, the court found that the warranty
actually consisted of two separate elements;
- that there had been no material adverse change in
Ultrapharm’s trading position or turnover; and - there had been no loss of a customer
representing more than 20% of Ultrapharm’s total sales.
The court therefore held that the 20% threshold only applied to
the ‘loss of a customer’ rather than imposing a
quantification on the reduction caused in trading or turnover.
Having undertaken that analysis though, the court went on to
determine (having also looked at other cases in which this issue
was considered, but recognising that there was no consensus on the
threshold for “materiality” in this context) that a
change in trading position exceeding 10% of group sales was
required to constitute a MAC. In this case, the
evidence did not support an actionable breach.
In relation to clause 2.1.9 the court held that the Price
Reductions were, in principle, matters that could have fallen
within the scope of that clause. However, as a matter of
construction, this warranty only covered Price Reductions after the
Accounts Date. The reductions in question had been agreed in
October 2017, before the 31 December 2017 Accounts Date. The
SPA date did not trigger the warranty, despite the
fact that the Price Reductions did not take effect until February
and April 2018 – dates that were well past the Accounts
Date.
Knowledge
The judge also considered whether the knowledge exception in the
SPA and the Policy (there were two exclusions, each
worded slightly differently) would operate to prevent cover in any
event.
If Finsbury had actual knowledge of the circumstances of a
warranty claim and was actually aware that such circumstances would
be reasonably likely to give rise to a warranty claim there could
be no actionable breach. In this case there was evidence to show
that a representative of the insured had actual knowledge of the
facts asserted to amount to a breach of warranty and that knowledge
was fatal to Finsbury’s claim.
Causation & valuation
Although ultimately irrelevant to the outcome given the earlier
findings, the court also held that Finsbury would have faced a
significant issue on causation and quantification of the claimed
loss.
The court held that Finsbury would have paid the purchase price
of £20 million regardless of the possibility that the
Ultrapharm business may have been overvalued – i.e. even with
the breaches of warranty, Finsbury would still have paid at least
£20 million for the business.
There were a number of factors in play, but the court took
particular account of compelling evidence that the sellers wanted
£20 million for the business and Finsbury would not have
walked away from the deal if a lower price could not have been
agreed. Whilst often tried by sellers in cases like this, the
specific approach to valuation in the underlying transaction and
the factual evidence combined to create a further insurmountable
hurdle for Finsbury.
Things to consider
- Whilst a claim under a W&I Policy may allow an
insurance claim to be made without the need for a breach of
warranty claim to be made against the seller first, this will not
negate the need to prove there has been a breach of warranty in the
underlying SPA (as well as requiring careful
consideration of the Policy documents). As with direct claims
against sellers under an SPA, a W&I
claim cannot be used to allow a purchaser to compensate for a bad
bargain. - A MAC clause may allow a party to claim for breach
of warranty and access remedies including a claim for compensation
for loss of value, however what is “material” for the
purposes of any given warranty will be a matter of construction of
the clause in context and will depend on the facts of each
individual case. As with many other elements of transaction
documents, clear drafting is key to ensuring that the bargain
struck is delivered, but the court will not hesitate to impose what
it considers an appropriate threshold in the absence of an agreed
definition. - Insurers will make use of knowledge exclusions in a
W&I Policy (along with any other policy defences
available to them) and this case is a prime example of their
importance. If the evidence shows that any deal team members whose
knowledge is relevant for the purpose of the knowledge exclusion
had the requisite level of knowledge at the relevant time, any
claim under the policy will be denied – even if there has
been a prima facie breach of warranty. For this reason, it
is important to make sure that the knowledge exclusion in the
policy is drafted as tightly as possible and, wherever possible, to
seek affirmative cover for any known risks. - Do not forget about causation as part of the loss calculation,
in addition to the pure quantification exercise. Even if the facts
illustrate there could have been a breach of warranty that breach
must have caused loss. If the Insured would have paid the purchase
price in any event there can be no claim (although this is often
hard to prove). For buyers, the ability to clearly demonstrate a
valuation methodology (and the levers to value) could be extremely
important.
Read the original article on GowlingWLG.com
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
