Court of Appeal interprets warranty that there had been no material adverse change in company's prospects and highlights need for careful compliance with notice provisions

A recent Court of Appeal decision has overturned a first instance finding that sellers of a company were liable for breach of a warranty that there had been "no material adverse change" in the company's prospects since the accounts date specified in the agreement: Decision Inc Holdings Proprietary Ltd v Garbett [2023] EWCA Civ 1284.

The decision illustrates that the courts will look carefully at the wording of such a warranty to determine what comparison is required in assessing whether there has been a material adverse change. In this case the clause required the court to compare the prospects of the company as at the accounts date (some nine months before the agreement was signed) with its prospects at the date of the agreement. That did not equate to comparing (as the judge had done) the expectations a reasonable buyer would have had on the date of the agreement and the actual position as at that date.

In any event, the Court of Appeal held that the sellers were not liable because the buyer had not given sufficient notice of the amount claimed in respect of each breach of warranty alleged. On a proper interpretation of the notice clause in the agreement, it was not sufficient to give an overall figure.

Background

The claimant Buyer brought a breach of warranty claim against the defendant Sellers following the acquisition of Copperman Consulting Ltd (the "Company"), an IT consultancy business that specialised in the design of enterprise performance management software.

Prior to signing the Sale and Purchase Agreement (SPA) on 8 October 2018, as part of the due diligence process, the Sellers supplied to the Buyer a number of pipeline and other documents bearing on the Company’s financial information, including management accounts up to July 2018.

Shortly after the SPA took effect, the Buyer was provided with the Company’s accounts for August and September 2018 (ie the two months preceding signing). These showed that the Company's turnover had been significantly lower than forecast by the Sellers.

The High Court (Gleeson J) found that the Sellers had breached a warranty in the SPA that, since the Accounts Date (defined as 31 December 2017), there had been "no material adverse change in the turnover, financial position or prospects of the Company” (the "Prospects Warranty").

The judge set out a three-stage process to determine if the Prospects Warranty had been breached:

1. What was the baseline figure, ie the expected level at the time of the contract? This was an objective test – what the parties would reasonably have agreed to be the "most likely estimate of the factor concerned over the period concerned".
2. What was the actual figure at the time of the contract? The ease of ascertaining the actual figure would depend heavily on the relevant factor. For example, the actual level of turnover could be established "by simple inspection of the books" but for a warranty "as to the future", some analysis may be necessary.
3. Is the difference between these figures so large as to be material? Again, this was an objective test – namely, "whether a reasonable person who had entered into the transaction with the aims and objectives of the buyer would have sought to withdraw from or renegotiate the transaction had he known of the change".

As to what "prospects" meant, the judge considered that future profitability was the parties' main concern and therefore focussed on the Company's predicted EBITDA. The judge found that the difference between the baseline and actual figures was indeed material, and therefore the Prospects Warranty had been breached.

He rejected the Sellers' argument that it was not liable because the Buyer's notice of claim had not met the requirements under the SPA, ie "notice in writing summarising the nature of the Claim (in so far as it is known to the Buyer) and, as far as is reasonably practicable, the amount claimed".

The Sellers appealed, and the principal issues on appeal were:

1. Was the judge's interpretation of, and approach to, the Prospects Warranty correct?
2. In any event, should the judge's order be set aside on the basis that the finding did not reflect the claim as pleaded or argued by the claimants?
3. Did the Buyer's notice of claim comply with the contractual requirements?

Decision

The Court of Appeal allowed the appeal. Newey LJ gave the lead judgment, with which Asplin and Baker LJJ agreed.

(1) Interpretation of the Prospects Warranty

The Court of Appeal found that the judge had erred in his analysis.

First, the judge used the wrong date. The correct approach would have been to evaluate the "prospects" as at 31 December 2017 (ie the Accounts Date) and as at October 2018 (when the SPA was signed). The judge had assessed the "actual" position in 2018 but contrasted that, not with the position as at 31 December 2017, but with the "expectation which a reasonable buyer would have had".

Secondly, the correct approach would have been to compare the same thing (ie "prospects") on different dates (31 December 2017 and October 2018). However, the judge had compared two different things on the same date (the expectation that a reasonable buyer would have had on the date of the SPA versus the actual prospects on the date of the SPA).

Thirdly, the period selected by the judge for the consideration of EBTIDA was problematic. The word "prospects" looks to the future" so the concern should have been with what might happen after the relevant date. However, the judge had focussed on EBITDA for 2018 even though more than nine months of that year had elapsed by the time the SPA was signed. This was to focus wrongly on what had already happened, rather than how the Company might fare in the coming period.

Fourth, the judgment had wrongly equated "prospects" with EBITDA. The Court of Appeal commented that “prospects”, read naturally, connotes “chances or opportunities for success” in a more general way – though the meaning could vary from one contract to another.

(2) Judge's finding did not reflect how claim argued

The Court of Appeal also concluded that the judge's approach was improper as a matter of procedural fairness.

The basis on which he found the warranty had been breached differed substantially from the way  the Buyer had set out its case in the Notice, the pleaded case and in submissions.

Accordingly, even if the judge’s reading of the Prospects Warranty had been correct, he could not properly have adopted it. As a matter of fairness, the Sellers had not had sufficient opportunity to address the basis on which the judge ultimately found the Prospects Warranty to have been breached.

(3) Adequacy of notice of claim

The relevant clause of the SPA qualified liability for breach of warranty in the following terms:

“The Sellers shall not be liable for a Claim unless notice in writing summarising the nature of the Claim (in so far as it is known to the Buyer) and, as far as is reasonably practicable, the amount claimed has been given by or on behalf of the Buyer to the Sellers".

The Court of Appeal held that, contrary to the judge's view, this clause required the Buyer to state the amount claimed in respect of each breach of warranty alleged as far as reasonably practicable, ie not just an omnibus figure. The fact that the Buyer's notice had not included the amount claimed in respect specifically of its claim for breach of the Prospects Warranty (as opposed to a total figure claimed, including for other alleged breaches) meant that the Sellers could not be held liable.