Breaches of warranty: what is the loss?

England and Wales

If an innocent buyer pays over and above the “true value” of a business – even assuming all warranties given by the seller are true – how should the buyer be compensated when some of those warranties turn out to be false?

The recent Court of Appeal decision in MDW Holdings Limited v Norvill [2022] EWCA Civ 883 is a useful illustration of how a simple breach of warranty in a share purchase agreement can present difficult damages questions when attempting to calculate “loss”.

Background

The dispute centred on warranties given under a share purchase agreement (SPA) relating to the sale of a business involved in the collection, processing and disposal of waste. The warranties given by the sellers under the agreement were extensive and included:

  • the business was operating in accordance with applicable law;
  • the business held all required consents and was not in breach of any terms and conditions of those consents;
  • the business had complied with environmental laws and permits; and
  • there were no facts or circumstances likely to lead to a breach of law, or the revocation, suspension, variation or non-renewal of a permit.

His Honour Judge Keyser QC (sitting as a judge of the High Court) at first instance found that the relevant business had, on multiple occasions, improperly discharged waste, that it had a “culture of lying to regulators when it was convenient to do so” and that, ultimately, not only had various warranties under the SPA been breached, but the sellers had given those warranties fraudulently. Ultimately, the buyer succeeded in establishing not only a breach of warranty under the SPA, but also that it had been induced to enter into the agreement by the sellers’ deceit.

The judge assessed the damages in the usual way for breach of warranty cases, being the difference between the value of the company on the basis that the warranties were true, and the actual value of the company given the warranties were false.

The appeal

The appeal focussed on how the judge had calculated the damages payable by the sellers. In particular, with the benefit of evidence from forensic accountants, the judge at first instance found that the “true value” of the business at the time of purchase, on the assumption all the warranties given under the share purchase agreement were true, was £3,341,276. The judge also found that the value of the business on the basis the warranties were false was £2,958,676. On that basis, he awarded damages of £382,600, comprising the difference between the two. Both the buyer and the sellers appealed.

The sellers argued that the judge had improperly reduced the overall value of the business by taking into consideration risks which had not materialised after execution of the SPA. In fact, there had been no prosecutions, no loss of permits and licences, and no suggestion of any reputational harm to the business. The sellers relied upon the fundamental compensatory principle of contract damages – that a party should be put in the same position that it would have been in had the contract been performed – to argue that, by failing to have regard to how matters had turned out subsequently, the damages awarded to the buyer placed it in a better position than that to which it was entitled.

The Court of Appeal decided that a purchaser knowing the truth at the date of the SPA would not only have reduced the purchase price to factor in lower future earnings (to account for the higher costs of disposing of all waste properly), but would also have lowered its price to account for the possibility of the business subsequently experiencing reputational damage from its past actions. Accordingly, the Court of Appeal found that the judge was right to disregard the fact that the hypothetical reputational damage had not occurred.

The buyer’s appeal centred on whether the proper basis for calculating damages was the actual price it paid (£3,584,224), or the lower hypothetical “true value” as found by the Judge. The buyer argued that the Judge should have had regard to the different bases for calculating damages (i) for a breach of contract, and (ii) for the tort of deceit. The fundamental principle of tort damages is that it places the innocent party in the same position it would have been in had the tort not occurred. The buyer argued the Judge should have applied the tortious principles of damages to the deceit claim, and awarded £625,548 in damages, having taken into account the higher actual price it paid for the company.

While agreeing with the buyer’s primary argument – that the tortious measure of damages should have been applied – the Court of Appeal also found that the deceit damages should not necessarily be calculated using the actual purchase price paid, but instead using the price that a purchaser would have paid had there been no deceit. As no findings were made on this issue by the judge, the Court of Appeal remitted the case back to the High Court to determine whether had it known the truth: (a) the buyer would not have proceeded with the purchase (in which case the damages would be £625,548); or (b) the buyer would still have proceeded with the purchase, albeit with a lower purchase price (in which case the damages would be the difference between the price paid (£3,584,224) and the price the buyer would have paid had it known the true position).

Comment

As different legal concepts can have different legal remedies in certain circumstances, it is critical that, should a dispute arise, proper consideration is given to all available remedies and options. Doing so ensures that possible claims are not being inadvertently missed or conceded. As was illustrated in this case, one of the two measures of damages produced a significantly more favourable outcome for the buyer, even though both claims were both based on the same underlying facts and conduct.

The case also highlights the importance of clearly documenting decision-making processes leading to the entry into a contract. Establishing what a party would have done had deceit not occurred – especially a long time after the relevant agreement has been finalised – is difficult. As the damages ultimately awarded may turn on these considerations, documenting the reasons for entering into a contract, whether there are any terms, warranties or representations that were particularly important, and what circumstances would lead the party not to proceed with the deal altogether, may well be relevant should such decisions need to be examined by a court in the future.