It pays to take notice

09 March 2023

Court highlights the importance of ensuring warranty claim notices comply with contractual requirements

The High Court has held that a buyer’s notice of claim for breach of warranty was invalid because it did not comply with the content requirements set out in the share sale agreement.


Three key take-aways
  • If a buyer and seller set out requirements for a notice of warranty claim, the buyer must comply with those requirements.
  • When deciding whether a notice is compliant, the court will ask what a reasonable recipient of the notice would have understood.
  • A non-compliant notice will be invalid and the buyer will need to start over. If the claims notification period has expired, the buyer could be left with no remedy.

What happened?

Drax Smart Generation Holdco Ltd v Scottish Power Retail Holdings Ltd [2023] EWHC 412 (Comm) concerned an agreement under which Drax acquired the shares in a company (the Company) from Scottish Power.

The buyer under the sale was Drax Smart Generation Holdco Ltd, a company within the Drax Group, and the seller was Scottish Power Retail Holdings Ltd, a company within the Scottish Power Group.

One of the Company’s key assets was a parcel of real estate that was a potential location for a new combined cycle gas turbine power station.

Any new power station would need to be connected to the national electricity grid at a neighbouring site. This would involve laying cables across a site owned by E.ON. To this end, another company within the Scottish Power group (SPDCL) had negotiated and entered into an option agreement with E.ON allowing SPDCL to demand an easement to allow it to lay the cables.

As a condition to the share sale, the seller was to ensure that SPDCL assigned the benefit of this option agreement to the Company, so that the Company would be able to acquire the easement and lay the cables in due course. This assignment would form part of a larger pre-sale reorganisation by Scottish Power.

To this end, the seller gave a warranty in the share sale agreement that, by the time the parties came to sign the sale agreement, “the reorganisation had been carried out” and “all transfers and other actions envisaged by the [reorganisation] had occurred”.

Separately, the seller also gave an indemnity in the share sale agreement, under which it promised to pay the buyer any losses arising from a failure to implement the reorganisation fully and correctly before the sale agreement was signed.

The sale completed and, in due course, the Company attempted to exercise the option. However, it turned out that, due to a technical defect, the option had not been validly assigned to the Company. The option exercise period subsequently expired before any action could be taken, leaving the Company with no legal right to lay cables to connect any new power station to the grid.

The buyer claims

Unsurprisingly, the buyer took steps to bring claims against the seller for breach of the warranty and for payment under the indemnity.

As is common, the share sale agreement contained a provision stating that, in order to bring certain types of claim against the seller, the buyer was required to serve a notice first on the seller, setting out certain information, within a specified period of time (depending on the type of claim).

In particular, the agreement required the buyer’s notice to state:

“in reasonable detail the nature of the claim and the amount claimed (including the Buyer’s calculation of the Loss thereby alleged to have been suffered)”.

Warranty claims notice requirements on a share sale

It is standard for a share sale agreement to state that a buyer cannot bring a warranty claim against the seller unless it gives the seller written notice of the claim, setting out certain information, within a specified period of time.

The time limits normally run from completion of the sale (i.e. when the shares are transferred and the price is paid). The period for notifying claims for breaches of core (or “fundamental”) warranties (such as ownership of the shares) and for tax-related warranties is normally a matter of years.

However, the time limit for notifying all other warranties is usually relatively short. Most agreements we see impose a time limit of 18 or 24 months. This is designed to give the buyer enough time to complete a full audit cycle on the target business and identify any possible claims.

Alongside the time limit, the sale agreement will normally also require the notice to set out certain specified information. This always varies from transaction to transaction but, most commonly, it will include details of:

  • the nature of the claim (which will normally mean stating that a claim is being made and referring to the relevant clauses in the sale agreement);
  • the matter giving rise to the claim (i.e. factual details of the circumstances that amount to a breach of warranty or other claim); and
  • the amount claimed.

The agreement will often limit the obligation to supplying reasonable details, recognising that the buyer will rarely be in a position to provide chapter and verse on its claim when it notifies the seller and that this will instead happen when legal proceedings are commenced. However, we also see sale agreements that require a buyer to notify “full particulars” of any claim.

Exactly what these requirements mean, and what information a buyer needs to provide, are a matter of interpreting the contract and will always depend on the specific circumstances in each case. However, the courts have considered warranty claim notices on many occasions now and issued a wealth of guidance on how to comply with notice requirements.

When deciding whether a notice complies with any contractual requirements, the court will examine what a “reasonable recipient” of the notice would have understood by it.

The buyer’s notice ran to nine pages and set out considerable detail of the nature of the claim. In particular, it noted that the Company was left with two options – to negotiate a new easement with the owner of the land or to apply for a compulsory purchase order – both of which would be more expensive than if the Company had been able to exercise the option.

The notice then went on to specify the nature of the loss. Critically, the notice included wording to the following effect (with bold wording indicating our own emphasis):

“Drax remains liable for any and all losses suffered by [the Company] in relation to the Reorganisation, and the fact that the Reorganisation (or any part thereof) was not implemented and completed in full …”

“In the circumstances, the loss suffered is yet to crystallise. As such, we set out below the details of the likely heads of loss … and where possible an estimate of the potential loss that is likely to be suffered.”

When it came to launching formal legal proceedings, the buyer set out the following statements in its particulars of claim (again, with our emphasis added in bold):

“The Claimant has suffered loss as a result of the said breaches of the SPA. Further, the Company has suffered (and will, in the future, suffer) loss as a result of the said breaches of the SPA.”

The Company has to date suffered losses in negotiating the acquisition of the Option Rights in the form of legal costs … The [Buyer] and / or the Company have to date suffered losses in negotiating the acquisition of the Option Rights on behalf of the Company in the form of lost management time in a sum to be assessed.”

“The Claimant anticipates that the Company will suffer the following further heads of loss in the future …”

Subsequently, after legal proceedings had commenced, the buyer sought permission to amend its particulars of claim to restate its loss in more conventional terms as:

“… the diminution in the value of the Company caused by the Defendant’s breaches of the SPA, and so as evidence of the loss it has suffered by reason of those breaches …”

How are damages for breach of warranty measured?

Breach of warranty entitles a buyer to bring a claim for breach of contract.

The conventional (but not the only) method of calculating the loss caused by a breach of contract is to award the innocent party an amount of damages sufficient to put that party in the position they would have been in if the contract had been performed properly.

So, in a simple example, if I contract to sell you (and you pay for) 20 widgets, but I only ever deliver you 15 widgets, I am in breach of contract and I would need to pay you the value of the missing five widgets. (That might be more or less than, or the same as, the price you paid for those five widgets, depending on whether you bought them at a bargain or a premium.)

On a sale of shares, the typical reference point is the value of the shares. If there is a breach of warranty, this will often be caused by some undisclosed loss or liability arising within the company which the buyer has acquired (or one of that company’s subsidiaries). This may, in turn, depress the value of the shares the buyer has bought.

The usual way of measuring the buyer’s loss in this scenario is to work out what the shares are worth with the breach of warranty and what they would have been worth if the breach of warranty had never happened. The difference between the two is the buyer’s loss.

So, for example, imagine a buyer acquires shares valued at £20 million but then discovers there has been a breach of warranty which results in the shares being worth only £17 million. The difference between the value with the breach (£17 million) and the value if it had not occurred (£20 million) is £3 million, and so that it what the buyer will be entitled to recover.

The position is not always clear, particularly if a buyer does not pay market value for the shares. So, imagine, in the example above, that the buyer had, for whatever reason, paid £22 million for the shares, even though they were worth only £20 million. Following the breach of warranty, the buyer will be out of pocket to the tune of £5 million. However, it will still be able to recover only £3 million, as that is the diminution in the value of the shares.

Conversely, if the buyer in the example above had paid £18 million for shares worth £20 million, it would be able to recover £3 million, even though it would be only £1 million out of pocket.

What did the seller say?

The seller claimed that the buyer’s notice was invalid, because it had not stated details or a calculation of the amount the buyer was claiming.

It claimed that the buyer’s notice set out details of loss suffered by the Company for which the buyer claimed it was, in turn, liable. However, the buyer had subsequently changed its claim to try to recover a diminution in the value of its shares that had arisen from the breach of warranty.

The seller said that this was a different type of loss from that specified in the buyer’s notice. As a result, the buyer had failed to comply with the content requirements for the notice set out in the sale agreement and, accordingly, the notice was invalid.

It is worth noting that the buyer sent its notice to the seller on the last day of the contractual period for notifying a breach of warranty claim. The consequence, therefore, if the buyer’s notice were invalid would be that the buyer would be unable to claim anything at all for the breach of warranty, because the buyer would be out of time for serving any new notice.

What are the consequences of sending a non-compliant notice?

The courts have repeatedly emphasised that the purpose of a claims notification clause is to give the parties – particularly the seller – clarity on their liability under the sale agreement.

Judges will treat commercial counterparties – particularly sophisticated, well-advised counterparties – like grown-ups and hold them to their contractual bargain.

As a result, if a warranty claim notice (or any other kind of claim notice) fails to comply with any requirements in the sale agreement, whether they be content requirements or time limits, the court will take a strict approach and declare the notice invalid and of no effect.

This can have severe consequences. In particular, if the buyer serves a warranty claim notice close to or on the deadline for notifying claims, but the notice later turns out to be invalid, the buyer may find itself out of time and unable to serve a subsequent, compliant notice. In that case, the buyer may be left with no ability whatsoever to recover from the seller.

This may seem harsh, but we have seen the courts reach this conclusion on several occasions:

What did the court say?

The court agreed with the seller.

The judge acknowledged that the notice had clearly identified the claims the buyer was bringing. A reasonable recipient of the notice would have understood why the claims were being notified.

However, the notice had not given reasonable detail in respect of the loss for which the buyer was claiming and its calculation.

In the judge’s view, a reasonable recipient of the notice would have understood from it that the loss described in it was “suffered in the first place by the Company, for which the buyer was liable”. They would not have understood that the buyer was claiming for a loss it had suffered directly or for any drop in the value of the shares it had acquired in the Company.

The judge gave several reasons for this.

  • The notice did not mention a diminution in the value of the shares at any point.
  • It did, however, state that the buyer remained liable for losses suffered by the Company. The judge said that the natural reading of this is that the buyer had entered into some form of agreement to indemnify the Company or somebody else for those losses, not that the buyer had suffered them directly.
  • The notice referred to losses likely to arise in the future. That was not consistent with a claim for a drop in the value of the shares, which would already have occurred and would have factored in the likelihood of not being able to obtain the easement without additional cost.
  • There was no reason to suggest that a reasonable recipient of the notice would have assumed that the buyer was claiming for a drop in the value of its shares simply because that is the normal measure for calculating loss arising from a breach of a warranty. This was particularly the case given that the notice specifically set out a different basis of loss.

As a result, the notice did not comply with the sale agreement and was invalid. The consequence of this is that the buyer was unable to bring a claim for breach of warranty.

What does this mean for me?

This could have been a drastic outcome for the buyer.

However, after some careful consideration of the time limits under the sale agreement (which were bespoke to this case), the court concluded that the buyer was entitled to claim reimbursement under the indemnity and that the notice in that regard was valid.

But, in another time and place where the seller had not given an indemnity, the result here is that the buyer would have been completely without remedy, merely because it had framed its loss incorrectly.

It is not clear why the buyer’s notice was phrased as it was, given that diminution in the value of shares is very much the usual starting point when assessing a breach of warranty claim. Indeed, although the case will (absent a settlement) proceed to full trial to examine the indemnity claim, given that the court gave summary judgment on the warranty claim, we may never know.

The fact is that this was an error that need not have occurred. If the notice had stated the conventional means of measuring loss (the means which, ultimately, the buyer adopted in its amended particulars of claim), the argument would not have arisen and the court would not have rejected the notice.

Above all, this shows the need to comply strictly with the relevant terms of the sale agreement when notifying a warranty claim (or, for that matter, an indemnity claim or a claim under any tax covenant). It is also a salutary warning against leaving a notice until the last moment.

A buyer who is considering bringing a claim under a share or asset sale agreement should keep the following points in mind.

  • Check the time limits. If the period for notifying claims has passed, the court will not allow the claim unless there has been some element of fraud or dishonesty on the seller’s part.
  • Don’t rush into notifying. Time limits are there for a reason. From a seller’s perspective, they provide an important cut-off point for liability. From a buyer’s perspective, they provide a period in which to carefully consider the merits of a claim and to set them out appropriately.
  • But don’t leave matters to the last moment. There can sometimes be tactical advantages in notifying a claim right at the end of the claims period. However, this can make the buyer a hostage to fortune or its own mistakes. If the claims notice is defective in some way, or it isn’t served properly under the sale agreement, the buyer may have wasted its only chance at recovery.
  • Make it clear what claim is being made. If the buyer is notifying a claim for breach of warranty, the notice should say so. Likewise, if the buyer is claiming under an indemnity or tax covenant, the notice should state this.
  • Refer to the relevant clauses of the sale agreement. For example, if notifying a warranty claim, the notice should state precisely which warranties the buyer believes have been breached. This can be done by clause number and by setting out the wording of the relevant warranties.
  • Explain why there has been a breach. This will usually involve setting out the factual circumstances and then relating them to the warranty or warranties in question, explaining why those facts are inconsistent with the warranty.
  • Include details of the loss. This may not be easy where the buyer has not yet been able to quantify the loss (because, for example, it needs to commission further analysis and valuation). However, even an estimate of the loss should suffice in most cases. Above all, check the requirements of the sale agreement to understand what level of detail is required.
  • Serve the notice properly. Most sale agreements contain clauses setting out precisely how contractual notices must be served – on whom, at which address and by what method. Failure to comply with these requirements can equally render a claims notice invalid.