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In the recent decision of Finsbury Foods Plc v Axis
Corporate Capital Ltd & Ors,1 the English and
Welsh Commercial Court dismissed a policyholder’s claim under a
buyer-side warranty & indemnity insurance policy issued in
connection with the acquisition of a manufacturer of gluten free
baked goods.
Ultimately, the dismissal was due to a failure of the insured to
establish breach of an insured warranty, causation and loss. There
are a number of key takeaways from the case, including the
interpretation of “material adverse change” in
the context of an insured warranty; the interpretation of
exceptions and exclusions that turn on actual knowledge of deal
team members; and loss valuation methodology.
The decision may provide guidance to the assessment of claims in
Australia in circumstances where there are very few local warranty
& indemnity insurance coverage decisions. We examine the
decision below.
Background
This case involved a claim by Finsbury Food Group Plc
(insured) against the underwriters of a buyer-side
warranty & indemnity insurance policy (Policy).
The Policy was issued on 31 August 2018 in connection with the
purchase of Ultrapharm by the insured pursuant to a sale and
purchase agreement (SPA). Ultrapharm was a
specialist manufacturer of gluten free baked goods and its largest
customer was major high-street retailer, Marks & Spencer.
Subject to its terms, the policy indemnified the insured against
the sellers’ liability under the SPA for, amongst other things,
breaches of insured warranties.
The insured claimed that Ultrapharm failed to disclose a recipe
change and key price reductions between Ultrapharm and Marks &
Spencer that amounted to breaches of insured warranties furnished
in the SPA that:
- there had been no material adverse change in the trading
position of Ultrapharm since the accounts date, being 31 December
2017 (trading conditions warranty); and - confirmed that, since the accounts date, there were no agreed
price reductions or discounts which would materially affect
Ultrapharm’s profitability (price reduction
warranty)
As to the trading conditions warranty, the insured asserted the
recipe change was materially adverse because it had a 14% or 9.5%
impact on the profitability of the two products affected by the
change.
As to both warranties, it was asserted that price reductions
offered to Marks & Spencer could be a basis on which they were
both breached.
The insured warranties were subject to a “knowledge
exception” under the SPA. There was also a
“knowledge exclusion” in the Policy. These
provisions broadly had the effect of excluding, respectively, the
liability of the seller under the SPA and any cover under the
Policy, if certain identified members of the insured’s deal
team had actual knowledge of the circumstances of the relevant
warranty claim.
Underwriters declined cover on the stated grounds that the
insured had not established breach of either of the insured
warranties; that both the knowledge exception and knowledge
exclusion applied; and that the insured had not in any event
established that the claimed breaches had caused any covered
loss.
In respect of their position on the knowledge exception and
knowledge exclusion, underwriters alleged that certain members of
the insured’s transaction team had knowledge of the relevant
price reductions before the SPA was entered into as the reductions
had been disclosed to the transaction team during the due diligence
process. The insured sued the underwriters for cover.
Judgment
The Court dismissed the claim, upholding the declinature on the
basis that neither of the insured warranties had been breached that
the knowledge exception under the SPA applied, and that the insured
had not established causation and loss, both being necessary
elements of establishing the sellers’ liability for the purpose
of the insuring clause of the policy.
Trading conditions warranty
The Court considered that there was no breach of the trading
conditions warranty because the recipe change was:
- agreed and took effect before the accounts date;
- part of the ordinary course of a bakery’s business and did
not, without more, fall within the ambit of the trading conditions
warranty; and - not a material adverse change.
In determining whether the recipe change constituted a
“material adverse change” in relation to the trading
position of Ultrapharm, the Court observed that the authorities did
not provide any set meaning to those words. Instead, the
authorities supported the view that the words meant something that
was “substantial or significant” as opposed to something
of a “de minimis” level.
In applying its reasoning, the Court rejected the insured’s
arguments that the change was materially adverse due to the stated
impact on the profitability of two products. The Court found that,
in this case, a “material adverse change“
required the total group sales of Ultrapharm to be impacted
adversely by more than 10% to constitute a breach of the trading
conditions warranty.
As to the price reductions offered to Marks & Spencer, the
Court found that “applying commercial common sense” to
the construction of the SPA showed that those reductions had been
treated separately by the parties and that they had applied
specific and separate criteria in order to evaluate whether there
had been a breach of the price reduction warranty. Accordingly, the
price reductions could not be relied upon to establish a breach of
the trading conditions warranty.
Price reduction warranty
The Court considered that there was no breach to the price
reduction warranty because:
- on its proper interpretation, the price reduction warranty was
concerned with price reductions that were offered or agreed to be
offered after the accounts date; and - on the evidence, the price reductions were offered by
Ultrapharm to Marks & Spencer before the accounts date and
therefore did not breach the price reduction warranty.
Knowledge exception and exclusion
Both the knowledge exception and knowledge exclusion were
capable of applying. However, as the knowledge exception was a term
of the SPA, the insured bore the onus of establishing that it did
not apply for the purpose of proving that the insuring clause in
the policy was triggered. In contrast, underwriters bore the onus
of establishing that the knowledge exclusion in the policy
applied.
Ultimately, the Court found that the knowledge exception applied
because:
- during meetings prior to the SPA being entered into, a member
of the transaction team specifically asked if there had been any
price reductions. He was informed that there had been price
reductions; and - the transaction team member was provided with pricing data
showing the price reductions. He then used the data to prepare a
presentation which included a discussion of the impact of the price
reductions.
In support of its findings, the Court found that the evidence
provided by some of the insured’s witnesses (including the
relevant transaction team member) was untruthful because, among
other things, it was inconsistent with the contemporaneous
documents.
Causation
Even if there was a breach, the insured would not have been
entitled to damages because it did not establish that any such
breach would have caused it loss. The Court found that causation
was not established because the insured would have proceeded with
the SPA at the agreed price of £20 million even if it had
known of the alleged breaches before entering the SPA for its own
strategic commercial reasons.
Valuation evidence
As the insured’s claim had failed on both liability and
causation, the Court dealt only briefly with quantum.
As to the value of Ultrapharm “as warranted” at the
date of the SPA , while the insured had assessed the value of
Ultrapharm on a 1 x sales basis and treated the purchase price as
fixed at GBP20 million, the Court noted that the conventional way
to value Ultrapharm was by taking a conventional run-rate EBITDA
multiplied by an appropriate multiple.
Despite the parties calling their own expert witnesses, for the
purpose of determining the “as warranted” value of
Ultrapharm, the Court adopted the EBITDA derived from the analysis
of the investment consultants engaged by the insured immediately
before the purchase of Ultrapharm. It also identified and adopted
the average of the multipliers used contemporaneously by advisors
to the transaction. This produced a valuation of approximately
GBP15 million to GBP17 million.
In determining the value of Ultrapharm if the warranties had not
been breached as alleged, the Court found that the actual value of
Ultrapharm (as assessed by the insured’s expert) was within the
range of what had been warranted in any event.
The Court also observed that, even if the insured had suffered a
loss, it would have been minded to assess the loss on a different
basis than that claimed by the insured. The Court would have
adopted the purchase price based on the method on which the insured
valued Ultrapharm (being 1x sales) and reduced that price by the
amount of reduction in sales, which would have produced a reduction
of GBP300,000 in the purchase price.
Key takeaways
There are a number of key takeaways from this case that are
potentially relevant for the assessment of W&I claims in
Australia.
The case demonstrates that assessment of whether there is a
breach of an insured warranty requires the interpretation of the
provisions of the underlying transaction document as a whole,
consistent with accepted principles of contract interpretation. In
this case, the terms of the trading conditions warranty were read
alongside of the price reduction warranty to identify the subject
matter and objective purpose of each warranty for the purpose of
determining whether there had been a breach.
The decision highlights that the meaning of “material
adverse change” in the context of an insured warranty will
require consideration of the precise facts and circumstances of the
target business and an assessment of the level of change that has
occurred against the business (in this case, at a group level).
What is ‘material’ may change from business to
business.
Exceptions from liability or exclusions of cover that turn on
actual knowledge impose a high evidentiary burden. Relying on such
provisions may require insurers to closely consider contemporaneous
documents and thoroughly investigate the due diligence process to
determine what was actually known by certain natural persons at the
relevant times. In this case, demonstrating actual knowledge
required the Court to reject the evidence of some of the
insured’s lay witnesses as untruthful. Predicting a finding on
credibility of this nature can be difficult at the time when an
insurer is assessing a claim advanced on a W&I policy.
The valuation analysis and advice obtained for the purpose of
the transaction may be relevant when a Court considers the value of
any claim advanced on a W&I policy. In this case,
contemporaneous valuation analysis and advice was given significant
weight by the Court in arriving at decision on quantum (including
with respect to the appropriate multipliers and the assessment of
EBITDA). The weight given to contemporaneous valuation analysis and
advice may be of assistance when assessing and adjusting a claim
advanced on a warranty.
Footnote
1[2023] EWHC 1559 (Comm)
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.
