A purchaser of a business needs to rely on the truth of the business seller’s promises about its financial position. This will include representations about its historic performance, current contracts and future business prospects. These promises about the financial position will be included as contractual warranties in a standard business Sale and Purchase Agreement (“SPA”).
If the purchaser acquires the business and then discovers that a warranty is false then the purchaser will have a claim for damages. That claim might be for breach of warranty by the seller or possibly it could be for fraudulent breach of warranty by the seller.
The financial differences of proving a contractual breach of warranty and proving a fraudulent breach of warranty can be significant. If the purchaser can prove fraud by the seller in giving an incorrect SPA warranty, then any contractual limit on the amount of damages recoverable for a breach of warranty would be removed. Proving fraud will entitle a purchaser to recover all of its financial losses incurred in buying the business.
Also any time deadline in the SPA which the purchaser has to start a claim for breach of warranty would also be automatically ineffective. So the purchaser would not need to bring a claim within for example three months of signing the SPA.
So the critical question in these disputes becomes what a purchaser must prove in order to prove a seller’s fraudulent breach of an SPA warranty.
In the recent case of Veranova Bidco LP v Johnson Matthey plc, the High Court Judge Mrs Justice Dias considered the purchaser’s claim that the seller of Johnson Matthey’s health business had breached a warranty fraudulently. In this case the SPA only permitted the buyer to sue the seller for breach of warranty where it could prove that the seller’s breach of warranty was fraudulent.
Ultimately, Veranova Bidco LP failed in its attempt to prove fraudulent breach. The Judge’s explanation of why it failed is instructive. The reasoning will assist purchasers of global businesses attempting to prove fraudulent breach of warranty where the seller has a number of negotiators providing information and financial data to the purchaser’s representatives.
The Judge’s reasoning will also apply to purchaser’s claims for untrue representations about the financial state of the business which a seller might make before the purchaser decides to buy the business.
What is the meaning of fraud in this context?
Essentially fraud in these cases is the seller being untruthful in giving a warranty about the position of the business. A purchaser must prove that when giving the warranty the seller either:
- knew that the warranty he was giving was false; or
- gave it without believing that it was true, or
- simply did not care whether it was true or false,
What was the Warranty in this Case?
The central warranty which Mrs Justice Dias had to consider was one which purchasers of businesses will frequently insist is included in an SPA. The seller must warrant that it is not discussing amendments to any of its important business contracts which might reduce the profitability of the business:
“Business Warranty 8.1.2: None of the Companies … is currently renegotiating any material term of any Key Contract, which upon conclusion, would have an adverse or detrimental effect on the Businesses”.
Did the Seller breach this Warranty?
Mrs Justice Dias ruled that the seller did breach the Warranty. This was because one of Johnson Matthey’s medical supply contracts contained a clause requiring Johnson Matthey to match any lower price offer made by a third party to the buyer of Johnson Matthey’s medical products. The Judge ruled that this price reduction should have been disclosed. That is because it would have an adverse or detrimental effect on the business. Johnson Matthey had breached the Warranty.
Did the seller breach the Warranty Fraudulently?
Fortunately for Johnson Matthey, Mrs Justice Dias ruled that whilst the sellers had breached the Warranty, there was no fraudulent breach.
There had been four Johnson Matthey executives representing it in the business sale negotiations to the purchaser. Under English law the knowledge of each of them becomes the corporate knowledge of Johnson Matthey.
For that reason the purchaser’s lawyers had argued that Johnson Matthey’s breach of the Warranty did qualify as a fraudulent breach. They submitted that in light of Johnson Matthey’s corporate knowledge that its SPA Warranty (no Key Contract was being renegotiated which could have a detrimental effect on the Business), was untrue, then all that the purchaser then needed to establish a fraudulent breach was:
(1) that any one of the four Johnson Matthey executives knew the relevant fact (that Johnson Matthey would have to reduce its pricing in the Key Contract) and
(2) that any other of the four Johnson Matthey executives knew that the relevant fact made the Warranty false.
On the facts of the case none of the four Johnson Matthey executives knew both (1) and (2), which is not surprising in such a large organisation.
Mrs Justice rejected this submission forcefully. It was legally incorrect. To establish fraudulent breach of the Warranty would require the purchaser to prove that one or more of the Johnson Matthey executives knew both:
(1) the relevant fact (that Johnson Matthey would have to reduce its pricing in the Key Contract) and
(2) that the relevant fact made the Warranty false.
To prove fraud requires the same individual who gives the warranty knowing, or not believing that it is true or not caring that it is false. English law does not permit a claimant to source the first of these fraud ingredients from one corporate individual and the second element from another.
How 3CS can help
Our expert dispute resolution solicitors Jonathan Cohen and Francesca Fraser and their team provide strategic and effective assistance in resolving commercial disputes.
For advice and guidance, please get in touch with our disputes experts.
