This issue has been the subject of a recent case, Sycamore Bidco Ltd. v. Breslin (2012), which shed light on how courts handle situations like these.
Due to the fact that both representations and warranties are frequently referred to in the same clause, standard contract drafting frequently leads to confusion. However, not every representation and warranty are the same thing. But it’s important to make the distinction because the options for treatment under each are very different. Let’s discuss the two regarding a share purchase agreement in detail.
To provide an explanation of the two’s distinctions:
A warranty is a specific clause in a contract that, if broken, can lead to a claim for damages. Damages are based on the idea that the wronged party should have been in the same position if the contract had been carried out correctly.
A representation, on the other hand, is a statement of fact or opinion made by one party to another usually before a formal contract is signed, so it is not usually a term in a contract. The buyer may be able to claim misrepresentation and have the contract rescinded (or declared “void”), which would enable a contract to be undone and award damages in the event that the representation proves to be incorrect.
The short facts of the Sycamore case are that, following an acquisition, the Buyers of a company believed they had discovered errors in the accounts of the target company, which they claimed had been relied upon prior to entering into the contract.
The warranties that the accounts “showed a true and fair view of the state of affairs… and profits… as at the date they were prepared…” and that they had been prepared in accordance with generally accepted accounting practice (GAAP) were included in the SPA. These warranties were fairly standard.
As a result, the Buyer filed a lawsuit against the seller for breach of warranty, which resulted in a claim that was worth somewhere in the range of £6 million. However, the Buyer also claimed that the breach of the aforementioned warranties was a misrepresentation that had induced it to complete the acquisition (which could result in the termination of the contract, which could be worth the entire £17 million consideration paid).
The High Court decided that there had been no representations, so there could not have been a misrepresentation. According to the Court, the relevant statements in the SPA were always referred to as “Warranties,” not as “representations.” Furthermore, the idea that a representation could be included in a contract did not hold water because misrepresentation should involve making a representation prior to the date of the Contract, not within it. However, the claim for breach of warranty was upheld because the accounts were actually inflated, did not provide a true and fair view of the situation, and was not in accordance with GAAP.
On the basis of damages, the difference between the price paid at completion and its actual value was deemed to be the loss caused by the warranty breach. The actual value was estimated to be £12 million due to the inflation of the turnover; consequently, the breach of warranty was valued somewhere in the range of $5 million. However, the value of the claim would have been significantly higher if the claim for misrepresentation had been successful.
The case serves as a useful reminder that clear language is required for the buyer and seller to include representations in a contract. If this is the case, the buyer should try to include a clause in which the seller acknowledges that it has made representations that have induced the recipient to enter into the agreement, even though it is unlikely that a prudent seller would ever accept this.
From the Seller’s perspective, they should make sure that the SPA does not include any references to representation and include a detailed clause that covers the entire agreement and tries to exclude any innocent or negligent misrepresentation based on the Agreement’s warranties.