Selling Shares In A Company? Think Twice About Warranties

The ‘buyer beware’ principle is a fundamental aspect of contract law. It’s up to purchasers to satisfy themselves that they are getting what they’re paying for. But a buyer’s responsibility to make enquiries only goes so far. When buying land for example the seller must disclose hidden defects in title to the buyer. And a well-advised purchaser of company shares will also seek to reduce risk by requiring the seller to give certain warranties about that company.

In this blog post we explain what warranties are. We also examine an English decision that judges here in the Bahamas will no doubt refer to when deciding similar cases. The case highlights the financial jeopardy a seller will be placed in when giving untrue warranties in a share purchase agreement.

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WHAT IS A WARRANTY?

All contracts are made up of different types of promises. There is a hierarchy of terms meaning that breaches of different types of term result in different legal remedies. Some breaches allow the party that is not in breach to completely repudiate the contract. This will happen if a condition of the contract is breached (because conditions are seen as going to the very heart of the contract). Breaches of other terms, including guarantees, indemnities and warranties, give a non- defaulting party other remedies. If a warranty is breached the normal recourse is for the affected party to sue for monetary damages. He or she will not normally be able to completely extricate him or herself from the contract. By way of example we looked at breach of speed and consumption warranties in a  shipping law context here.

SHARE PURCHASE AGREEMENTS AND WARRANTIES

A seller of shares in a company will commonly use warranties to facilitate and finalise a share purchase agreement. Warranties provide a buyer with reassurance that he or she will have some kind of legal recourse if, following the share purchase, some undisclosed risk materialises or the value of the shares is undermined by something that ought to have been disclosed during the sale process.

Warranties can cover matters such as human resources and employment issues, ownership of company assets and details of company compliance with regulations such as data protection and company law. The case we look at below shows what can happen when a seller of shares breaches multiple warranties.

EQUITIX EEEF BIOMASS 2 LTD V FOX [2021]

This case from the English High Court resulted from the sale by a number of individuals (the defendants) of all the shares in an energy company (Gaia) to another company (Equitix). The sellers gave several significant warranties in the Share Purchase Agreement, including that:

• Gaia was compliant with environmental targets and permits
• Gaia’s boilers were in good working order
• Gaia’s major contract with a company called Greenenegy was unproblematic

In fact, it transpired that because of problems with maintenance and operation of Gaia’s boilers, the contract with Greenenergy was terminated.

The court found that the warranties were false and that there should have been full disclosure of the operational problems before the sale was completed. The court ordered the sellers to pay £11 million in damages to the purchaser.

COMMENT

This was a lengthy and detailed judgment, running to almost 600 paragraphs. But one comment from Mr Justice Kerr stands out. When discussing the failure of the sellers to give the purchaser a full picture of the difficulties that were being experienced in operating Gaia’s boilers the judge said:

Instead of explaining these defects (in the boilers)to Equitix  and attempting to operate the boilers properly, the defendants played down the defects and continued …. to keep Equitix interested in the deal.

This one paragraph encapsulates the precise behaviour share purchase warranties are designed to guard against. This case might appear extreme given the extent of the warranties that were breached and the amount of damages the seller was ordered to pay.  Nevertheless it makes clear that sellers in any situation –no matter how routine the contact may at first appear – should take great care about the warranties they give and the level of detail they disclose about the asset they are selling.

CONTACT US

For advice on commercial contracts, including share purchase agreements and feel free to reach out to us at ParrisWhittaker for an initial, no-obligation discussion.