All English corporate lawyers and, many of their clients, will be intimately familiar with the process of negotiating warranties and disclosures as part of commercial deals.  The functions of those warranties and any disclosures are well known: to elicit information about the target and to qualify any warranties given.  What is less well understood, but of crucial significance to both parties, is the extent of disclosure that must be made by a vendor to forestall any warranty claims and whether, in the context of such a claim, a purchaser will be prevented from suing for breach of warranty because his agents were aware of it before entering the agreement.  A recent decision of the English Court of Appeal makes clear that the English courts will look to the terms of the agreement to determine both of these points. Accordingly, anybody concluding a contract subject to English law should take particular care to negotiate and correctly document the position in relation to these areas.

 

Infiniteland Ltd and John Steward Aviss v Artisan Contracting Ltd [2005] EWCA Civ 758 concerned the acquisition, by share purchase, of a group of companies.  The seller had warranted that the accounts of that group gave a true and fair view of the relevant target companies’ financial position.  It came to light, post-completion, (and after the insolvency of one of the companies) that the accounts of that insolvent company had been drawn up such that an exceptional item in the accounts (a one-off intra-group payment) had been used to reduce the cost of sales and increase profits (“the Accounting Issue). The purchaser sued for breach of warranty.

 

The share sale agreement stated that the warranties were true and accurate in all respects, “save as set out in the Disclosure Letter”.  The disclosure letter provided for general and specific disclosure and deemed all “matters from the documents and written information” supplied to the purchaser’s reporting accountants to be included in the disclosure letter.  A substantial amount of documentation and various explanations by telephone were provided by the vendors’ accountants to the purchaser’s reporting accountant. One of the matters disclosed was the Accounting Issue. However, the reporting accountant failed to inform the purchaser of the Accounting Issue.

 

General vs Specific Disclosure

 

At trial, it was common ground between the parties that the accounts did not show a true and fair view.  However, the Court of Appeal held that the documents provided to the reporting accountants and the explanation provided by the vendors’ accountants to the purchaser’s accountants made sufficient disclosure of the Accounting Issue.  In reaching this decision, the Court of Appeal laid to rest a common misconception that there is an objective standard of disclosure applicable in all cases.  Rather, the sufficiency or otherwise of disclosure is to be measured by reference to the provisions of the contract in each case. 

 

The Court of Appeal considered that the purchaser’s decision not to insist on specific disclosures against the relevant warranties meant that it was content for its reporting accountants to identify from the documents supplied to them – and to report on – the matters about which it needed to be informed.  Given that decision not to require specific disclosures against each relevant warranty, Chadwick LJ stated that in these circumstances, sufficient disclosure was made if there was ascertainable from the documents provided:

 

“such matters as might fairly be expected to come to the knowledge of the reporting accountants from an examination (in the ordinary course of carrying out the due diligence exercise for which they were engaged) of the documents and written information supplied to them…”. 

 

If a purchaser chooses to accept general disclosure to his accountants in this way, then he may find, depending on the terms of the agreement as to disclosure, that matters in a set of accounts can qualify the warranties, even if the purchaser is unaware of them.

Actual Knowledge

 

A key clause of the agreement (“Clause 7”) provided that:

 

“the purchaser’s rights and remedies in respect of any breach of the Warranty shall not be affected…by any investigation made by it or on its behalf into the affairs of any Group Company (except to the extent that such investigation gives the Purchaser actual knowledge of the relevant facts and circumstances underlying its warranty claim.”

 

It appears from the judgment that clauses in substantially similar form to Clause 7 will be prevalent in English law sale and purchase agreements due to their availability in a popular English precedent book, The Encyclopaedia of Forms and Precedents. Accordingly, even though the Court of Appeal held that there had been no breach of warranty it still went on to make some observations about the meaning of “actual knowledge” in such clauses.

 

The reporting accountant was found to have been aware of the Accounting Issue. However, for whatever reason, he did not inform the purchaser about it. Chadwick and Carnwath LJJ agreed that “actual knowledge” in this context was to be given its settled meaning.  Accordingly, an agent’s knowledge about something (whether actual or constructive) is not to be imputed to his purchaser principal unless the agreement between the parties so provides.  Therefore, the purchaser in this case did not have actual knowledge of what his accountant discovered about the Accounting Issue, and was in a position to sue for breach of warranty (unsuccessfully as it turned out). 

 

What the case also suggests is that a purchaser with actual knowledge of a breach of warranty prior to completion is not prevented from completing and then suing in respect of that breach. However, it is clear from the judgment that any such warranty claim would be likely to fail in the face of a defence that the purchaser had actual knowledge of the breach complained of.

 

Dissent

 

Interestingly, Pill LJ, took a different and (arguably, more commercially realistic view, at least from the vendor’s perspective) that, if an accountant is instructed to undertake due diligence, then the purchaser is held to have the accountant’s actual knowledge imputed to him.  Pill LJ’s reasoning in this regard was that the parties cannot have intended that the risk of the purchaser’s accountant failing in his tasks should be put back on to the vendor.  Time will tell whether the pro-vendor dissent of Pill LJ finds any favour, in an appropriate case, with the House of Lords.

 

Conclusions

 

Objective Standard of Disclosure?

 

There is no objective standard of disclosure which will apply in every case. The parties must agree what level of disclosure is to be provided by the vendor. If it is agreed that specific disclosure will be made (and it is, in fact made), there should be little or no scope to bring a warranty claim. However, if, as is considered more likely, the parties agree on general disclosure, then sufficient disclosure is made to prevent a warranty claim, if the documents supplied disclose:

 

“such matters as might fairly be expected to come to the knowledge of the reporting accountants from an examination (in the ordinary course of carrying out the due diligence exercise for which they were engaged) of the documents and written information supplied to them…”.

 

Does ‘actual knowledge’ of a breach of warranty prevent a post-completion warranty claim?

 

The case suggests that a purchaser with actual knowledge of a breach of warranty prior to completion will be able to complete and then sue for breach of warranty.  Accordingly, a vendor should seek to provide against this possibility in the sale and purchase agreement by, inter alia, stipulating that the purchaser’s or its agents’ actual knowledge be imputed to the purchaser to relieve liability for breach of warranty. Clearly, this is likely to meet with strong opposition from the purchaser. In any event, and even absent such drafting, it is unlikely to play well with the courts, for a purchaser who entered into a contract in full awareness of a breach of warranty to then bring a claim in respect of it.  However, the most appropriate solution for a purchaser in this situation would still be to address the issue before exchange of contracts (i.e. by seeking an indemnity or reduction in purchase price). 

 

In any event, it would appear that the parties to an agreement will now pay much closer attention to their approach to disclosure and to whether a purchaser’s agents’ knowledge of breaches of warranty are to be deemed to be within the purchaser’s knowledge prior to completion.