Court of Appeal confirms the meaning of “goodwill” in share purchase agreements

The Court of Appeal recently gave a significant decision about the meaning of “goodwill” in the context of analysing an exclusion of liability clause in a contract for the sale of a business (Primus International Holding Company v Triumph Controls – UK Limited [2020] EWCA Civ 1228). Rather than adopting the definition of goodwill used by accountants, the Court confirmed that the concept should be given its ordinary or commercial meaning in such a contract – just like any other term. In this instance, the Court concluded that “goodwill” was “a proprietary right representing the reputation, good name and connections of a business”.

Background

In 2013, the parties entered into a share purchase agreement (“SPA”) documenting the sale to Triumph, a defence services provider based in Pennsylvania, USA, of two of aerospace manufacturing companies owned by Primus, a multinational manufacturer of complex metal components.

The purchase price was approximately USD76.5 million. When the companies were sold, they were making a loss but Primus’ financial forecasts for the companies to 2017 – which the parties discussed in some detail before agreeing the sale – predicted that the companies would be profitable within a few years.

As 2013 went on, Triumph discovered serious operational and business problems with the companies. After significant efforts to turn the businesses around, including the injection of approximately USD85 million, the companies were approximately USD120 million in debt and Triumph viewed the shares it had purchased as “worthless”.

Triumph issued proceedings in 2015, claiming damages for, amongst other things, breach of the following warranty in the SPA:

19.5 So far as the Sellers are aware, the forward-looking projections relating to the Companies have been honestly and carefully prepared. (“Warranty”)

In response to this claim, Primus relied on the following exclusion clause which appeared in a schedule of the SPA:

3.1 No Claim, claim under the Tax Warranties or, where specifically referenced, an Indemnity Claim, shall be admissible and the Sellers shall not be liable in respect thereof to the extent that…

(f) The matter to which the claim relates:

(i) Is in respect of lost goodwill… (“Exclusion Clause”)

Decision

First instance

O’Farrell J found that Primus had breached the Warranty by providing Triumph with financial forecasts containing forward-looking projections that were not “honestly and carefully prepared”. She rejected Primus’ argument that it was not liable to Triumph because the claim fell within the Exclusion Clause. She held that the ordinary meaning of “goodwill” is “business reputation” and that the losses Triumph had suffered because of Primus’ breach were not “lost goodwill”.

O’Farrell J calculated that, but for that breach, the purchase price that Triumph paid under the SPA would have been approximately USD5.7 million lower to reflect the reduction in the forecasted performance of the companies. After subtracting a deductible provided for in the SPA from that amount, she awarded Triumph damages of approximately USD4.2 million.

Appeal

Primus applied for permission to appeal from the order of O’Farrell J on many grounds but was granted permission in respect of the scope of the Exclusion Clause only. The Court of Appeal (Henderson, Coulson and Carr LLJ) agreed with the decision at first instance and dismissed Primus’ appeal.

In doing so, the Court had to consider two competing definitions of “goodwill”. Triumph argued that “goodwill” as used in the Exclusion Clause should be given its ordinary commercial meaning, being “the good name, business reputation and connections of a business”. Primus argued that the proper meaning of “goodwill” was “a loss of share value, where that value represents the difference between the cost of acquisition and the fair value of its identifiable net assets and/or where that loss of share value is caused by the impairment of the value of non-identifiable assets.” Primus’ definition was an accountants’ one and Primus referred to a paper prepared by PwC to support its argument.

The Court of Appeal preferred the ordinary commercial meaning over the accounting definition for four reasons.

1. Ordinary legal meaning. Somewhat unusually, neither party argued, or led evidence to suggest, that the factual background to the SPA assisted in construing the Exclusion Clause. Therefore, when construing the Exclusion Clause, the Court did not need to go beyond the actual words used as read in the context of the SPA as a whole. The Court referred to multiple sources that established that the “ordinary legal meaning” of “goodwill” was the meaning contended for by Triumph. There was no reason for the Court to depart from the ordinary legal meaning here.
2. Authorities. The applicable case law, stretching back to Austen v Boys in 1858, confirmed that the courts have long given “goodwill” the meaning that Triumph contended for rather than the accounting definition.
3. Use of the concept elsewhere in the SPA. Where “goodwill” was used in other parts of the SPA, it was clearly being used in the sense contended for by Triumph, rather than in the accounting sense. For example, clause 1.1 defined “Intellectual Property” to include “rights to goodwill” and clause 13, titled “Protection of Goodwill” contained detailed undertakings not to employ certain named employees for two years after the sale which suggested that “goodwill” was a broader concept than merely something on a balance sheet at the time of the sale.
4. Nature of the claim. The nature of Triumph’s claim was a claim for overpayment as a result of careless financial forecasts. This was entirely different from a claim for loss of reputation, good name or business connections. Moreover, if the Exclusion Clause was construed using the accounting definition, it would have extended to all claims in respect of parts of the purchase price not covered by the value of the net assets of the companies at the time of sale. This would have the result that the Warranty would have no work to do at all, as it would be almost inevitable that breaches of the Warranty would not relate to the net value of assets at the time of sale but to overly optimistic promises about future value.

Implications

The Court of Appeal has confirmed that typically (but subject always to the context of the contract in question) the meaning of “goodwill” when used without further explanation in an SPA is the good name, business reputation and connections of a business. The courts will not ascribe to “goodwill” its technical accounting definition unless there is good reason for departing from its ordinary legal meaning.

The importance of documenting agreements, including definitions, carefully cannot be overstated. As the Court of Appeal stated: “If a contract contains a term to which the parties intend to give an unusual or technical or non-legal meaning, that must be spelt out.”