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Knowledge and warranties
In the Sycamore Bidco case (see also other articles ‘Share sales: what’s the difference between ‘The Sellers warrant…’ and ‘the Sellers warrant and represent…’?‘ and ‘One of several shareholders giving warranties in a share sale? Be careful!‘) the share sale agreement had a clause which said that the sellers wouldn’t be liable under the warranties to the extent that the buyer, having made due enquiries of certain members of the MBO team, was actually aware at completion of facts which would give it a claim for breach of warranty.
Some of the MBO team members who became directors of the buyer did know of facts which would give the buyer a claim. So, the question was, did the knowledge of those MBO team members constitute ‘actual knowledge’ of the buyer, so that the buyer couldn’t bring a claim?
You might have thought that something known by a director of the buyer should be said to be known by the buyer? Well, you’d have been wrong. Under English law the knowledge of a director is not automatically imputed to his appointing company. It all depends on the particular facts (ie, the judge can decide what he thinks is fair in all the circumstances, and then set out reasons). The judge in this case said that the MBO team members’ knowledge was acquired in their capacity as directors of the target company, while on the seller’s side of the line, and that he could see no reason for their knowledge to be suddenly treated as that of the buyer. He thought that to do so would defeat the purpose of the warranties.
On another day, in another case, with different facts, another judge might say different if he thinks it would be fairer…perhaps depending on whether he sees the clause as protecting the seller director who knew about the possible claim from being liable under his own warranties, or protecting another seller who knew nothing of the facts.
An example of how warranty negotiations can pan out; and what IS the purpose of warranties?
This kind of clause is not at all common. You often see similarly worded clauses but the other way round. Some warranties are expressed as absolute statements of fact. Others are stated to be correct ‘so far as the sellers are aware’. A buyer’s first draft of the share purchase agreement might start with a warranty worded as fact, eg ‘there are no circumstances which could give rise to any claims against the company’. The sellers might want to water this down, ideally to something along the lines that ‘the company hasn’t received notice of any claim…’. The buyer will ask for more, saying that if someone in the company knows of a possible claim in the offing then the sellers should bear the risk. The sellers will say they can’t ask everyone in the company to look at all the warranties and say if there’s anything they know which might make them incorrect. It’s impractical and anyway most staff aren’t meant to know about the impending share sale. The buyer might say, well ok, we’ll water it down so it says that the sellers are not aware…but that ‘awareness’ includes anything of which they ought reasonably to have been aware after making ‘all appropriate enquiries’. The parties will then argue over what might and might not have been appropriate. Since it’s usually impossible to agree in detail on this, they often simply leave it to a court with hindsight to decide. They might also agree which particular people, eg senior management, should be asked.
Or the seller may take a tougher stance and say that if it’s not aware of a breach of warranty then there should be no claim.
The argument then often comes down to what is the purpose of the warranties in the first place. They are there to encourage the seller to make disclosures so that the buyer has as much information as possible to decide whether it wants to buy the shares, and at what price. They are also there to allocate risk of the unknown.
Here, the buyer will say that the price it is prepared to pay assumes there is no unknown liability which hasn’t been taken into account. The seller will say that the reason it is selling, at the agreed price it is prepared to accept, is because it can walk clean away from the company and leave it to the buyer to take on the ongoing risks of the unknown. The seller may say that if the buyer really insists on having such warranties, then correspondingly the agreement should provide that if there is some unexpected benefit or item of value that the seller didn’t know about, or for example if a claim which both parties knew about fails ultimately to materialise, then the buyer should end up paying the seller even more for the shares. Both parties and their lawyers (teams of lawyers if you are using a traditional full service firm) can sit around a big table for hours on end racking up huge costs while the lawyers spout all the arguments.
Ultimately, logic and reasoning aren’t what decide matters – the parties usually end up with a list of outstanding points, which might be so-called ‘deal-breakers’ or more minor points (depending on what the different parties think about them) , and if they want to do the deal they resolve things by trading some against others. This often happens after a late night or all-night meeting which makes the participants feel tough and important.