Summary
The normal measure of damages will be the difference between the ‘true value’ of the company and the ‘as warranted’ value (almost invariably, the court will find this is the same as the purchase price agreed under the SPA).
In OCBC , the Court considered and rejected an argument that the “normal” measure of damages should be departed from.
The Facts
OCBC was a claim for breach of warranty under an SPA entered into in October 2009. The defendant, ING , had warranted that the 2008 accounts gave a true and fair view of the state of affairs of the target company. The breach of warranty claim related to an alleged failure to properly record potential liabilities in the company’s accounts for 2008. The liabilities related to equity derivative transactions with Lehman Brothers, in respect of which, upon the collapse of Lehman Brothers, early termination payments became due. Following a dispute, liabilities of USD 14.5m were established as payable.
Overseas Chinese argued that the derivatives gave rise to a contingent liability which was not, but should have been, included as such in the target company’s 2008 accounts, and the failure to do so gave rise to a breach of a warranty in the SPA because the accounts had not (the Claimant argued) given a true and fair view of the company’s position.
Overseas Chinese asserted that, had the derivatives been disclosed as a contingent liability in the 2008 accounts, it would have negotiated an indemnity to cover the liability of USD 14.5m which eventually crystallised. It claimed USD14.5m on the basis that this represented its loss from a breach of the warranty that the accounts were true and fair.
ING argued that Overseas Chinese’s approach to calculating its loss was not available. With reference to preceding authorities, ING contended there was no reason for the court to depart from the normal basis on which to assess loss, whereby the purchaser is entitled to recover the difference between the “true” value of the shares and the value of the shares as warranted. Whilst the judgment does not comment upon this, we assume that any claim for damages calculated on this basis would have been substantially less than USD 14.5m because, the value of the target company being USD 1.466bn, the inclusion in the accounts of a contingent liability for such a relatively small amount would not translate into a materially lower “true” value.
The Decision
The Court agreed with ING . The Court did not accept Overseas Chinese’s submission that the authorities supported its argument that the “normal” approach was only a prima facie measure of damages for breach of warranty under an SPA from which a court may depart.
The Court also determined that Overseas Chinese had not, in any event, established that the accounts were not true and fair so as to give rise to a breach of warranty nor that it would have obtained the requisite indemnity from ING to cover any contingent liability in respect of the Lehman derivatives as it alleged.
Commentary
It is, in our view, not surprising that the claim failed. The warranty in question is a standard warranty on a share sale, it is given to ensure that the purchaser is getting what it contracted to buy, and not a company of lesser value. As the Court held, there is nothing about the reported facts of this case which suggest the normal approach towards calculating damages for breach of such a warranty should not be followed.
The decision in OCBC confirms that there will be limited scope for a purchaser to argue for departure from the usual measure of damages. In our view, such departure may only be achieved when it could be argued that the particular warranty is not aimed, as most are, at protecting the purchaser from basing its purchase price upon wrong financial information and buying a company of lesser value.
An example where departure from the usual measure would be justified, is damages associated with breach of the tax indemnities in an SPA. Contingent, or undisclosed, tax liabilities are not likely to be relevant to the purchaser’s valuation, but nor would the purchaser expect to be liable for them when they arise – the purchaser requires a specific indemnity, to respond on pound for pound for such future liabilities.
W&I Insurers
The Court’s affirmation of the usual measure of damages in OCBC will be of interest to insurers when considering the potential value of claims made under W&I policies.
Where a company is sold as a going concern, it is normal for the purchase price to be calculated by application of an appropriate multiplier to the company’s annual profits (/EBITDA). In turn, where there are breaches of warranties, loss is measured by determining the effect of those breaches on maintainable profits and then applying the same multiple to determine their effect on the value of the
company.
As the Court of Appeal held in the leading authority of Senate Electrical , in most cases where the original price was calculated by application of a multiple to profits “… the obvious way to calculate the damages [is] by applying the same multiplier to the shortfall in maintainable earnings/profits ” (see: Senate Electrical Wholesalers Ltd v Alcatel Submarine Networks Ltd 1998).
The decision in OCBC underlines the value of having W&I insurance to purchaser and sellers alike, as the application of a multiplier to losses will often give rise to large claims. It also highlights the need for sellers and W&I insurers to be wary of unusual breach of warranty claims, based upon arguments claiming loss other than on the normal basis.
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