Anyone buying a house is familiar with the principle of caveat emptor, let the buyer beware, which is the rationale behind the obtaining of surveys to check the condition of the property. The same principle applies in the purchase of company shares. The purchaser is buying an entity with all its rights and liabilities. The change of ownership doesn’t affect these rights and obligations. Accordingly purchasers of shares will seek to reduce their risks by obtaining extensive warranties and indemnities.
A warranty is a contractual statement and relates to the state of affairs of the target company. In the event that the warranty statement proves untrue, which is in effect a breach of the warranty, then the purchaser will be awarded damages if he proves the breach and the value of the shares have been reduced as a result of the breach.
Often in any transaction the due diligence process or the inclusion of extensive warranties in the draft agreement will reveal issues or flush out matters of concern to the purchaser. The purchaser can then choose to walk away, negotiate a price reduction or proceed with a specific indemnity for the matter of concern. An indemnity is a promise to reimburse the purchaser should a liability arise or a known liability crystallize. It allows the purchaser to recover his loss on a pound–for–pound basis even if he knew about the problem prior to buying the shares.
A recent High Court decision in England, Oversea-Chinese Banking Corp Ltd (“OCBC”) v ING Bank NV, highlighted the lack of protection for a purchaser where there was no specific indemnity for the matter of concern and the warranty, whilst breached, did not allow for any damages. In this case the sale and purchase agreement provided a standard warranty that the accounts for the Company gave a true and fair view of its state of affairs at a particular year end. It transpired that a liability had been wrongly quantified in the accounts. However despite the incorrect statement of the liability it appeared that the value of the shares would not have been less even if the liability was correctly stated. This meant that the purchaser could not recover any damages under the warranty. The purchaser had accepted this and did not attempt to sue on the warranty, acknowledging the lack of diminution on the share value. They took the novel approach arguing that had the liability been correctly stated they would have sought an indemnity rather than seeking to rely on a warranty.
The judge rejected OCBC’s claim. The hypothetical indemnity measure was not available to as a matter of law. The judge’s decision did not depart from the general rule concerning the measure of damages on a share sale and remained consistent to other Court rulings.
This case highlights the distinction between warranties and indemnities and the importance to any purchaser of shares in understanding the different measure of damages and where available obtaining an indemnity from the Vendor of shares for material matters of concern.
Celia Worthington is a Consultant in the Corporate, Commercial & Charity law department of Worthingtons Solicitors. For advice on buying or selling businesses, shareholder disputes or disagreements please telephone our Commercial Department on 02890279500 or email [email protected]o.uk
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