Post-M&A Disputes Series

Delineating the relationship between warranties and indemnities

Warranties and indemnities allocate risks between the buyer and the seller regarding the asset being sold (in an SPA, shares). Without them, the general default position is “caveat emptor” or “buyer beware”, meaning the buyer would have limited recourse against the seller (primarily those arising under statute only where the shares were expressly stated to have been transferred with “full title guarantee” or “limited title guarantee”).

• Warranties provide assurances about the state of the target company—its assets, liabilities, operations, and compliance—serving as a factual baseline on which the buyer relies when agreeing to the purchase, and consequently underpin the price paid for the shares. If warranties, as contractual statements of fact about the target company, turn out to be false, the buyer must prove breach, loss, and causation—typically under the general rules of contractual damages.
• Indemnities, in turn, offer specific remedies in the event of a particular event or circumstances arising post-completion.  Usually, indemnities are negotiated to cover known risks that are identified during due diligence (especially those risks that are hard or impossible to quantify pre-signing).  They are usually drafted to provide an on demand, pound-for-pound recovery in respect of the issue falling within its scope which should be treated as a debt not a damages claim.

Together, warranties and indemnities help protect the buyer from hidden and known risks and financial losses while giving the seller clarity on the extent of their ongoing exposure and greater transactional certainty. They can each also be subject to different contractual limitations of liability.

Concurrent warranty and indemnity claims in Learning Curve

The Learning Curve judgment examined the relationship between the indemnities and warranties in the SPA. The facts of the case are summarised in Part 1, but essentially following Learning Curve’s (the “Buyer”) acquisition of AP Cymru Ltd (the “Company”), an audit identified over-claimed funding by the Company, resulting in a clawback by the funding bodies of £783,325 (the “Clawback”).

The Buyer sought to recover this amount both through a specific indemnity and via a separate claim for breach of warranty. Under the “Funding Indemnity”, the Sellers agreed to indemnify the Buyer in respect of "the clawback, recovery or repayment to ESFA… of any sums paid to any Group company in the period from 1 March 2018 up to and including the Completion Date…".

The SPA also contained several warranties, including warranty B5.2.2(a), which stated that the Company had complied with the “Funding Rules” and was entitled to receive all funding under contracts in place with ESFA, the Welsh Government, and other providers.

The Sellers paid the Clawback amount (£783,325) to the Buyer under the Funding Indemnity, but the Buyer nevertheless argued that it had a claim for breach of warranty, because the impact of the breach of the Funding Rules meant that the quality of the asset purchased under the SPA (the shares of the Company) was not what it was warranted to be, even if, the Company was compensated in relation to the Clawback.

The distinction between whether the Buyer claimed under the Funding Indemnity or for breach of warranties was important for various reasons:

• Quantification of loss: Under the Funding Indemnity, the recovery would be limited to the Clawback amount (£783,325) and costs.  In a breach of warranty claim, the measure of loss would be the difference between (i) the value of the shares of the Company when comparing the value assuming the warranties to be true (the “warranty true” value) compared with (ii) the value of the shares in their true condition (the “warranty false” value).  The Buyer claimed the value of its claim was some £10.1 million.
• Limitations on warranty claims: Various contractual limitations applied to warranty claims that would not apply (in the same way) to an indemnity claim.  For example, the Sellers were not liable for any “Warranty Claim” if the facts were disclosed in the Disclosure Letter or were within the actual knowledge of the Buyer at the date of the Agreement.  Further, the Sellers’ liability under the warranties was limited to the amount of consideration received by them, whereas under the Funding Indemnity, liability was limited to 50% of the amount of consideration received.
• Double Claims Provision: The Buyer could not recover more than once for the same fact, matter, event, or circumstance.

The court held that the Sellers had breached several warranties in the SPA, including the key warranty. Accordingly, the Buyer had good claims under both the Funding Indemnity (which the Sellers had already paid) and for breach of warranty.

Double Claims – does a right to an indemnity preclude a warranty claim?

The Sellers argued that it would be commercially illogical to allow a warranty claim where a specific indemnity already applied and could potentially lead to double recovery. The court rejected this -  the Buyer’s ability to claim under the Funding Indemnity did not preclude any warranty claim.

However, the Buyer did need to elect whether to pursue the claim under the Funding Indemnity or the warranty claim; it could not maintain both claims. A crucial factor in reaching this conclusion was the SPA’s “double claims” clause, which stated that if the same matter gave rise to both an indemnity and a warranty claim, the Buyer could not recover more than once. The clause ensured that the Buyer could not achieve double recovery, but it did not prevent both claims from arising. The key provisions in the SPA which influenced the court’s decision included:

• The SPA expressly stated that the warranties were "not limited or restricted by reference to or inference from…any other term of [the SPA]".
• The SPA provided different caps on the Sellers’ liability for indemnities and warranties, recognising that one may be greater than the other. The SPA allocated to the Sellers the risk that a warranty claim in respect of the Clawback might be greater than a claim under the Funding Indemnity.
• The Funding Indemnity was expressed to be "Without prejudice to any other rights or remedies available to the [Buyer]", directly undermining the Sellers’ argument that the Funding Indemnity prejudiced the Buyer's warranty claim.
• The Sellers' argument was therefore at odds with the clear language used in several distinct terms of the SPA.

It is worth noting that such provisions are not always present in SPAs, even ones where a specific indemnity has been agreed to supplement warranties.

Having concluded that the warranties were breached, the Buyer was in a position to elect between claiming under the Funding Indemnity and the warranties. It is notable in this case that the leverage effect of adjusting the multiple in calculating the diminution in the value of the shares meant that the Buyer could argue that its damages would far exceed the value of the Clawback (£783,325) and in the event it secured a damages award of some £5.2 million. We will examine the quantification of the warranty claim in Part 4 of this series.

Conclusion

Practitioners often consider that an indemnity offers better protection for a Buyer than a warranty, and Learning Curve itself illustrates that there are often significant obstacles that a buyer needs to clear in order to make good a warranty claim. However, when an issue arises post-completion that has a broader impact on the value of the company beyond the target’s losses that might be indemnified, warranty claims should be considered. The valuation of a damages claim for a breach of warranty may substantially exceed the amount that could fall within the scope of an indemnity.

The key learning points arising from this aspect of the judgment include:

1. Indemnities and warranties operate under distinct contractual principles, even when they relate to the same underlying issue. Careful drafting, thoughtful claims strategy, and a clear understanding of risk allocation are essential for companies navigating M&A transactions and post-M&A disputes.
2. In this instance, the specific indemnity did not negate the possibility of a separate warranty claim. The judgment carefully distinguished between limiting double recovery -explicitly addressed in the SPA -and preventing separate claims for the same underlying issue, which the SPA did not (and which the SPA recognised through its wording could arise).
3. Even where a specific indemnity exists, it may still be possible to bring a warranty claim for the same issue.  Carefully consider the scope of the warranties and indemnities and their respective liability caps before electing the specific claims being brought.
4. Drafting in the SPA should reflect the parties’ intentions regarding risk allocation, recovery, and remedies.  Any provisions seeking to prevent double claims (as opposed to double recovery) should be explicit to avoid ambiguity or unintended restrictions.