Legal Updates

M&A update – new judgment on distinction between warranties and representations

Written by Henry Evans

Legal and Commercial Background

When entering into contracts, and when buying and selling companies in particular, it is important to be clear about the meaning and significance of all the contractual terms. However, the technicalities of English contract law (as with other legal systems) can sometimes be a trap for the unwary, particularly with regard to the distinction between “representations” and “warranties”. This has been underlined by a recent case heard before the Commercial Court, Idemnitsu Kosan Co Ltd v Sumitomo Co Corp [2016] EWHC 1909 (Comm).

A representation is generally a statement of fact (or an opinion) given by one party to another before a contract is entered into. If a party enters into the contract in reliance on the representation and the representation turns out to be incorrect, the party may bring a claim for misrepresentation and the contract can be rescinded, meaning that the contract becomes void and the parties are put back into the position that they were in before the contract was entered into (though monetary damages are more usual).

A warranty, on the other hand, is a term of the contract itself. If a warranty is incorrect, the innocent party may have a claim for breach of contract. If a claim for breach of contract is successful, the innocent party may be awarded monetary damages to put it into the position that it would have been in had the warranty been correct. If the warranty is an important one which goes to the heart of the contract, a breach of warranty may be found to be a repudiatory breach; in such a case the innocent party can terminate the contract, so that the contract comes to an end. It cannot, however, rescind the contract and so be put back into the position it would have been in if the contract had never been entered into, as in the case of misrepresentation.

In the context of the sale of a company, the seller will usually give warranties about the company being sold in the contract for the sale of the shares in the company being sold (SPA), usually located with other warranties in a separate schedule to the SPA (for example that its accounts give a true and fair reflection of the company’s finances, that the company has title to any property that it claims to own, that the company does not have any outstanding loans other than those that the buyer knows about, and so on). These take the form of statements about the company; if any are incorrect or need clarification then it is for the sellers to let the buyers know through a disclosure letter, or else risk facing a claim for breach of contract.

The position gets confused

Although one might have thought that there was a clear distinction between a warranty and a representation, the position has traditionally been confused by legal draftsmen referring to the contractual terms in the SPA as being both warranties and representations. At the same time, there have been decided cases where what was on the face of it simply a warranty has been held in fact to be a representation, with consequential results.

In Invertec Ltd v De Mol Holding BV [2009] EWHC 2471 (Ch) the Court held that warranties in an SPA were also likely to be representations and that a buyer could bring a misrepresentation claim in the event that a warranty was incorrect. By contrast, in Sycamore Bidco Ltd v Breslin & Anor [2012] EWHC 3443 (Ch) the Court decided not to follow the ruling in the Invertec case, and held that warranties in an SPA which are not expressed to also be representations will not be representations.

Background to the Idemitsu case

In 2009 Sumitomo, a Japanese general trading company, entered an SPA to sell the shares in a subsidiary to Idemitsu, a Japanese oil company, for a sum in the region of $570 million.

The SPA contained a large number of warranties, as is usual in an SPA, as well as clauses limiting the liability of the seller regarding claims made under the warranties. Specifically, there were cut-off dates for claims relating to certain warranties, such that if a claim under a specific warranty was not brought within a certain period of time from the completion of the SPA, no claim could be brought under that warranty at all.

In addition, the SPA, as is also usual, contained an “entire agreement” clause. This clause is so-called because it confirms that the SPA (and any documents referred to in it) contains the whole of the agreement between the parties and that no party has relied on any statements or undertakings of any kind made between the parties before the contract, so that any verbal or written correspondence before entering into the contract cannot be construed as either forming a part of the contract or being a representation.

Some time after completion of the sale, the buyer concluded that some of the warranties had been incorrect at the time that the SPA completed. However, the buyer was too late to bring a claim under the warranties in the usual way, as the cut-off time (18 months in this case) had passed.

Since it was time-barred from bringing a warranty claim, the buyer decided instead to bring a misrepresentation claim against the seller, claiming around $105 million. The buyer claimed that:

  • the warranties in the completed SPA itself were also representations, even though they were not expressly designated as such in the SPA; and
  • the seller had made representations prior to completion of the SPA by having provided a final version of the SPA for signing and by having actually signed it.

The buyer argued that the warranties should be treated as representations, regardless of whether the warranties in the completed SPA were representations or not.

The seller applied to the Court for summary judgment (by which a court makes a finding without the need for a full trial) on the basis that the claim made by the buyer had no real prospect of succeeding.

The Court’s decision

The Court agreed with the seller that the buyer’s claim for misrepresentation had no real prospect of success and so the case was thrown out.

The Court found that the warranties in question were definitely warranties but that they were not representations. The Court followed Sycamore Bidco rather than Invertec and held that the making of a statement (by way of a warranty) and a promise that the statement is true (by a representation) are not necessarily the same. On the facts, the wording of the SPA showed that it was not intended that the warranties should be representations; clauses dealing separately with representations and warranties were in different parts of SPA and the warranties were stated only to have been warranties, not representations and warranties.

The Court found further that the SPA did not suggest that it was the intention of the parties that the warranties ought to also be representations; this was a commercial transaction in which both sides were advised by experienced lawyers and so, had the parties intended the warranties to be representations, this would have been expressed in the SPA. It would therefore be wrong, the Court held, to contend that the seller had made a representation by providing or signing an execution copy of the SPA: this was merely intended to get the deal over the line in the final agreed form, rather than to make representations out of the warranties.

The Court also took note of the entire agreement clause in the SPA, which made it clear that no pre-contractual representations had been relied upon by the buyers, since this was further evidence that the warranties in the execution version of the SPA could not have been representations, and so a claim for misrepresentation was bound to fail.

Conclusions to be drawn

This judgment in the Idemitsu case provides welcome certainty to parties entering into contracts, in particular SPAs. It provides a reminder that, as ever when drafting documents, clear wording should be used for the avoidance of uncertainty.

The judgment provides comfort to sellers, as it underlines that they will be very unlikely to be subject to a successful misrepresentation claim, which could put the contract at risk of being rescinded, as a result of a breach of a warranty which is not expressed to be a representation as well. The case also shows that sellers are well-advised to insist on a well-drafted entire agreement clause, as this can prevent a seller from facing a claim for misrepresentation as well as one for breach of contract in the event that a warranty which is not also a representation turns out to be incorrect.

For buyers, this case shows that if it is the intention of the parties that a warranty is to be a representation and not just a warranty, that the SPA should be drafted as such, otherwise a warranty will likely be found only to be a warranty and not a representation. Buyers should also consider carefully what if any limitations to accept on the liability of sellers under the warranties; in this case the seller was able to escape any liability for breach of warranties because of an advantageous cut-off period relating to the relevant warranty. Where there is a cut-off period, one should be particularly careful to keep an eye on the calendar, as missing the deadline for a claim can leave a party unable to make a claim, even when a warranty has clearly been breached.

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Henry Evans

Gordon Dadds