In the first warranty & indemnity insurance
(“W&I“) claim to be decided by the
Commercial Court, the Defendant insurers succeeded on every issue,
with the Court finding that there had not been a breach of the
relevant warranties and indeed no loss as the buyer would have paid
the full purchase price in any event.
Background
The Claimant, Finsbury, is a group of food manufacturing
companies, including various bakery businesses. Finsbury brought
these proceedings against the Defendant insurers under a Buyside
Warranty and Indemnity Insurance Policy (the
“Policy“). Finsbury had obtained the
Policy to insure the sellers’ liability in connection with its
purchase of Ultrapharm – a specialist manufacturer of gluten
free baked goods – from the shareholders of Ultrapharm
pursuant to a Sale and Purchase Agreement
(“SPA“). Both the Policy and the SPA
were dated 31 August 2018.
Finsbury’s acquisition of Ultrapharm was motivated by its
desire to re-enter the “gluten free”
(“GF“) and “free from”
(“FF“) markets and Finsbury considered
Ultrapharm’s GF bread products to be the best tasting in that
market. One of Ultrapharm’s biggest customers was Marks and
Spencer plc (“M&S“).
Following the acquisition, Finsbury claimed that warranties
provided by the CEO of Ultrapharm, Mr Marc Lewis, had been breached
and that those breaches were covered by the Policy. Finsbury
claimed more than £3 million from the Defendant insurers,
which it said constituted the difference between the as
warranted value of Ultrapharm and the actual value of
Ultrapharm, at the time of its purchase on 31 August 2018.
The key issues to be decided by the Court were:
- Whether certain recipe changes and product price reductions
agreed to between Ultrapharm and M&S amounted to a breach of
the relevant warranties under the SPA (the “Trading
Conditions Warranty” and the “Price
Reduction Warranty” respectively). - Whether, if any of the relevant warranties were so breached,
the relevant individuals at Finsbury had the requisite knowledge so
as to: (i) vitiate the sellers’ liability for breach of
warranty under the SPA; or (ii) exclude the Defendant insurers’
obligation to provide indemnity under the Policy (the
“Knowledge Exclusions“). - What the loss, if any, was to Finsbury, and indeed whether if
there was a loss on the purchase, Finsbury was responsible for that
because it would have paid the full purchase price of £20
million for Ultrapharm even if it had known that its
actual value was less.
Analysis of the Commercial Court decision
No Breach
In assessing the question of breach, the Court was faced with
two key issues:
- The meaning of the words “material adverse change”
for the purposes of the Trading Conditions Warranty. - Whether the recipe changes and the price reduction (which fell
to be considered pursuant to the Trading Conditions Warranty and
the Price Reduction Warranty respectively) had been agreed and/or
enacted prior to 31 December 2017 (the “Accounts
Date“), for the purposes of giving effect to the
words “Since the Accounts Date” in the
warranties clause in the SPA.
In respect of the first issue, the Trading Conditions Warranty
provided that since the Accounts Date there had been no material
adverse change in the trading position of the target group or their
financial position, prospects or turnover and no target group
company had had its business, profitability or prospects adversely
affected by the loss of any customer representing more than 20% of
the total sales of the target group companies. The Court agreed
with Finsbury’s argument that, properly construed, these were
separate warranties within the same clause and Finsbury was
successful in arguing that the “material adverse change”
referred to in the Trading Conditions Warranty, for which there is
no set meaning that has been ascribed in the authorities, did not
mean a loss of 20% in turnover which the Defendant insurers had
argued for. The Court, however, did determine that a material
adverse change must exceed 10% of the total group sales of
Ultrapharm in order to constitute a breach of the Trading
Conditions Warranty. The Court provided no reasoning for its
finding of 10%, which, along with its reference to there being no
set meaning of the words “material adverse change” in the
case law, demonstrates that the inclusion of these words, without
greater precision, may increase the uncertainty of where a court
may draw the line in the event of a dispute. Despite the limited
evidence of the financial impact of the recipe change before the
Court, Mr Persey KC did conclude that the impact on the
profitability of the two products which were subject to the recipe
change could “not have amounted to anything like
10%” of total sales, and in any event recipe changes were
part of the ordinary course of a bakery’s business.
On the second issue, the Court was satisfied that the recipe
changes had been agreed and implemented prior to the Accounts Date
and the judgment records no argument from Finsbury as to that
point. Finsbury did, however, argue that the price reduction, while
agreed prior to the Accounts Date had not actually been implemented
by 31 December 2017. Finsbury argued that the purpose of the Price
Reduction Warranty was to “give the purchaser comfort that
the true picture of Ultrapharm’s position
vis-á-vis its trade with customers is visible from
the accounts prepared to the Account Date of 31 December
2017“. The Defendant insurers argued that the natural
meaning of the words “no Group company has offered
or agreed to offer ongoing price reductions“
[emphasis added] was clear and that implementation was not
required. The Court found that argument to be compelling and
concluded that the warranties clearly applied only to events which
had occurred after the Accounts Date of 31 December 2017 for the
purposes of protecting the position as between that date and the
conclusion of the SPA. The existence of a Price Reduction Warranty
of this kind, which includes wording about such a reduction being
offered or agreed to be offered does not therefore protect a buyer
against agreed price decreases that were yet to come into effect or
avoid the need for a buyer to conduct the necessary due diligence
beyond a review of product prices set out in the target’s
accounts.
“The SPA is not intended to be a panacea to resolve
any unforeseen consequences of Finsbury’s admittedly light
touch approach to due diligence.”
The impact of Finsbury’s
knowledge
The burden of proof was on the Defendant insurers in seeking to
rely upon the Knowledge Exclusions, which were in fairly
conventional form in requiring that a member of the buyer’s
transaction team had actual knowledge of the breach that is alleged
to give rise to the loss. While “Actual Knowledge” was
defined in the Policy and did not include constructive or imputed
knowledge, it was ultimately common ground that it would
nonetheless include wilful blindness (sometimes referred to as
Nelsonian knowledge). Having found that the evidence of two key
Finsbury witnesses relevant to the knowledge of a member of
Finsbury’s deal team as to the price reduction was
“untruthful“, the Court was satisfied that a
member of the deal team did have sufficient information available
to him for the Knowledge Exclusionsto apply.
No loss
The final question of substance considered by the Court was
whether the buyer would have purchased the target for the same
amount in any event. In this case, the Court was satisfied that
Finsbury would have done so, based on the documentary evidence
which showed that despite Ultrapharm’s EBITDA falling over the
course of the negotiations, the agreed purchase price never changed
(or was sought to be changed) from its original figure of £20
million. This was the price that the sellers required and it was
the price that represented the perceived value to Finsbury of
Ultrapharm based on factors including its eagerness to re-enter the
GF/FF market. Due to this finding, the question as to how to
measure the as warranted value of the business was otiose.
While the experts for both sides agreed that the conventional way
to value Ultrapharm is by taking a conventional run-rate EBITDA
multiplied by an appropriate multiple, the Court found it
“appropriate to stress that [Finsbury, for the
reasons referred to above] did not at the time seek to value
Ultrapharm in the conventional way” and Mr Persey KC came
to the conclusion that there was in fact “no “as
warranted” value for Ultrapharm at the time the company was
sold to Finsbury“.
The impact of Finsbury’s
knowledge
The burden of proof was on the Defendant insurers in seeking to
rely upon the Knowledge Exclusions, which were in fairly
conventional form in requiring that a member of the buyer’s
transaction team had actual knowledge of the breach that is alleged
to give rise to the loss. While “Actual Knowledge” was
defined in the Policy and did not include constructive or imputed
knowledge, it was ultimately common ground that it would
nonetheless include wilful blindness (sometimes referred to as
Nelsonian knowledge). Having found that the evidence of two key
Finsbury witnesses relevant to the knowledge of a member of
Finsbury’s deal team as to the price reduction was
“untruthful“, the Court was satisfied that a
member of the deal team did have sufficient information available
to him for the Knowledge Exclusionsto apply.
No loss
The final question of substance considered by the Court was
whether the buyer would have purchased the target for the same
amount in any event. In this case, the Court was satisfied that
Finsbury would have done so, based on the documentary evidence
which showed that despite Ultrapharm’s EBITDA falling over the
course of the negotiations, the agreed purchase price never changed
(or was sought to be changed) from its original figure of £20
million. This was the price that the sellers required and it was
the price that represented the perceived value to Finsbury of
Ultrapharm based on factors including its eagerness to re-enter the
GF/FF market. Due to this finding, the question as to how to
measure the as warranted value of the business was otiose.
While the experts for both sides agreed that the conventional way
to value Ultrapharm is by taking a conventional run-rate EBITDA
multiplied by an appropriate multiple, the Court found it
“appropriate to stress that [Finsbury, for the
reasons referred to above] did not at the time seek to value
Ultrapharm in the conventional way” and Mr Persey KC came
to the conclusion that there was in fact “no “as
warranted” value for Ultrapharm at the time the company was
sold to Finsbury“.
Key Takeaways
This case acts as an always important reminder that the courts
will not use their interpretation of a contract to step in to save
a party merely because the bargain it has struck, with the benefit
of hindsight, is demonstrably ill-advised, or even disastrous. It
also serves to demonstrate the particular importance of disclosure
to insurers in W&I proceedings due to the information asymmetry
between an insured party and the Defendant insurer and that the
purpose of an SPA (and indeed, a W&I policy) is not to be a
cure-all for a light touch approach to due diligence.
While breach was not established in this case, this case
highlights the mistake it would be to assume that, in the event a
breach of warranty is proven, a finding of loss will naturally
flow. In this case, where the Court found there was no loss
suffered, Finsbury’s documents were particularly important in
demonstrating how the purchase price for Ultrapharm was negotiated
and the factors that were important to Finsbury in the transaction,
in support of the Court’s finding that Finsbury would have
proceeded with the acquisition in any event.
Finally, and crucially, the judgment reiterates the principle
that insureds (and deal teams) cannot rely on wilfully ignoring
information that would lead to them having actual knowledge of a
breach of warranty – a point for both insurers and insureds
to bear in mind.
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.
