Court finds notice of warranty was valid and compliant after all

14 May 2024

The Court of Appeal has held that a notice of warranty claim was valid and complied with the requirements of a share purchase agreement.

The High Court had originally held that the notice had misstated the nature of the buyer’s loss because it had referred to losses suffered by the company that had been acquired, rather than losses suffered by the buyer due to a drop in the value of the shares it had purchased.

What happened?

Drax Smart Generation Holdco Ltd v Scottish Power Retail Holdings Ltd [2024] EWCA Civ 477 concerned a share purchase agreement (SPA) 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. The seller negotiated an option with the owner of that site (E.ON) to acquire it. The option had to be exercised within an option period.

As part of the sale, the seller undertook to assign the option to the Company so that the buyer would have the benefit of it following the acquisition. This would take place as part of a reorganisation.

To this end, the seller gave a warranty in the SPA that, by the time the parties came to sign the SPA, “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 SPA, under which it promised to pay the buyer any losses arising from a failure to implement the reorganisation fully and correctly before the SPA 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 initial claim

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 SPA contained a provision stating that, to bring certain types of claim against the seller, the buyer was required to serve a notice, 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 (our emphasis added):

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)

The buyer served a notice of claim that ran to nine pages. The notice covered both a claim for breach of warranty and a claim under the indemnity.

It elaborated on the facts and set out two bases of potential loss. However, critically for the buyer, it referred to loss suffered by the Company, whereas a claim for breach of warranty would need to reflect loss suffered by the buyer.

The High Court found that the notice did not meet the requirements in the SPA for a notice of breach of warranty. It said that the nature of the buyer’s warranty claim was damages for the loss in the value of its shares in the Company.

However, the notice referred instead to loss suffered by the Company. Applying the legal test, a reasonable recipient of the buyer’s notice would not have understood this to mean that the buyer was attempting to recover the reduction in the value of its shares in the Company through a warranty claim.

The buyer had given the notice on the last day of the period for notifying warranty claims. The result of the court declaring the notice invalid was that the buyer was now “out of time” and unable to bring a claim for breach of warranty.

The court did, however, find that the notice met the requirements for notice of a claim under the indemnity in the SPA.

You can read more about the High Court’s decision that the notice of warranty claim was invalid in our previous Corporate Law Update.

The buyer appealed the High Court’s decision that the notice of warranty claim was invalid. The seller cross-appealed its decision that the notice of indemnity was valid.

What did the Court of Appeal say?

The Court of Appeal upheld the buyer’s appeal and found that the notice had in fact complied with the requirements in the SPA for a notice of a warranty claim.

The judges agreed with the initial decision of the High Court that it was not possible to read the buyer’s notice as putting forward a claim for the drop in the value of the buyer’s shares, which is, properly speaking, what a claim for breach warranty is.

However, they said that this did not render the notice of warranty claim invalid. The nature of the claim – rather than being a reduction in the value of the buyer’s shares – was “straightforward”. In the words of Males LJ: “It was simply a claim that under the terms of the [SPA], the Company ought to have had the benefit of the [option], but did not.

Indeed, the court went on to say that it was not convinced that the buyer was even required to identify the terms of the SPA which the seller had breached. Rather, a simple statement that the seller had failed to ensure the Company had the benefit of the option would have told it all it needed to know.

In reaching this conclusion, the court made some important comments of principle. It noted that:

[n]otice of [c]laim clauses should not become a technical minefield to be navigated, divorced from the underlying merits of a buyer’s claim”,

and that:

courts should not interpret such clauses as imposing requirements which serve no real commercial purpose unless compelled to do so by the language of the clause”.

The court also dismissed the seller’s cross-appeal, finding that the notice also amounted to a valid notice of claim under the indemnity in the SPA.

Warranty claims notice requirements on a share sale

A share or business sale agreement will often 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 usually run from completion of the sale (i.e. when the shares are transferred and the price is paid) and will depend heavily on the nature of the business being sold, the respective bargaining power of the buyer and seller, and intersection with any warranty and indemnity insurance.

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.

By contrast, the time limit for notifying a breach of any other warranty can be quite short and as little as 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 limits, the sale agreement will normally also require the notice to set out certain specified information. Again, this varies from transaction to transaction, but it may 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.

A sale agreement may limit the obligation to supplying reasonable details, recognising that a buyer is rarely in a position to provide chapter and verse on its claim when it notifies a seller. (This will happen instead when legal proceedings are commenced. However, it is possible for a sale agreement to require a buyer to notify full particulars of a claim.)

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

What does this mean for me?

This is clearly a pragmatic decision that seeks to prioritise justice over formality.

In reaching its decision, the High Court had taken what might be described as an overly formalistic view of the buyer’s notice, finding that there was no way the seller could reasonably be expected to have inferred that the buyer was bringing a warranty claim.

This finding was difficult to reconcile with the fact that the notice specifically stated that it was notifying a breach of warranty. Although the notice went on to describe the loss to the Company, rather than the loss to the buyer, it does seem slightly tenuous to conclude that it deprived the notice of being a notice of warranty claim, particularly given the clear wording.

In this sense, the judgment is helpful for buyers (whether of shares or of assets), as it demonstrates the courts’ willingness to interpret sensibly notices of claim in light of the surrounding context.

That said, the court did make some interesting remarks that arguably create a murkier picture for buyers and sellers alike.

For example, the judges commented that it may not have been necessary for the buyer to specify what parts of the SPA the seller had allegedly breached. But in other cases, the courts have held that it is necessary to specify the precise provisions alleged to have been contravened. (In Teoco UK Ltd v Aircom Jersey 4 Ltd [2015] EWCA Civ 23, for example, the buyer failed to identify which warranties it believed the seller had breached, resulting in its notice of claim being declared invalid.)

It is good to see courts exercising a pragmatic approach (particularly where parties have already been discussing and the seller can’t really be in any doubt as to the substance of the claim).

But equally there is value in a seller’s right to know what kind of claim it may be defending. Preparations for, arguments against and potential compensation stemming from, say, a breach of warranty claim can be quite different from a payment under a specific indemnity.

Also noteworthy are the court’s comments on the extent to which the burden fell on the seller in this case. It felt that “a simple statement that [the seller] had failed in its obligation […] would have told the seller Power all that it needed to know”.

The judgment goes on:

If the seller had been “in any doubt about its contractual obligations […], it had only to read the [SPA] or to ask a lawyer for advice. If it wished to investigate whether it had a defence to the claim […], it would know in which files to look or which individuals to ask. If it wished to assess its potential liability […], it would be able to obtain legal advice.

Whilst these statements are undoubtedly true, they imply that a buyer can put in a relatively thin notice of claim and shift the burden of establishing the substance of the claim onto a seller.

Warranties are contractual promises, and courts will naturally be inclined to hold a seller to its promises. Likewise, limitations of liability – including requirements to give notice of a potential claim in a stipulated form – are exclusion clauses and will naturally be interpreted narrowly.

But, equally, a seller naturally has an interest in understanding the kind of claim it is facing. One has to remember that claims notification periods can be long (often up to seven years, for example, for tax claims) and, following completion of a sale, it is the buyer – not the seller – that will be in possession of all the relevant documentation and background.

To be fair, in this case, the parties had already engaged in discussions on the issue in question (and, indeed, had made specific amendments to their SPA to deal with it) and the facts giving rise to the breach were straightforward. It would have been artificial to suggest that the seller needed any more information to understand what the buyer was alleging.

The position would arguably be very different for, say, a breach of a warranty that the target company’s accounts are accurate. That kind of a claim is likely to be far more technical and complex, no doubt requiring a detailed explanation of the matters giving rise to the breach and which warranties are rendered untrue by those matters.

When all is said and done, the key point remains that a buyer looking to bring a claim must ensure that any required notice of claim meets the contractual requirements of the SPA. In this regard, a buyer should consider taking the following steps.

  • Read the relevant provisions of the SPA to understand what the notice of claim must contain. Often, the SPA will require the notice to state the nature of the claim and the amount being claimed (or a reasonable estimate of that amount). Failure to comply with the contractual content requirements for the notice is likely to render the notice invalid.
  • Specify what kind of claim the buyer is bringing (e.g. a warranty claim, a claim under an indemnity or a claim for misrepresentation).
  • Identify the relevant provisions of the SPA alleged to have been breached. For example, if the claim is for breach of warranty, the notice should enumerate the relevant warranties. This need not be exhaustive: the notice could cite several warranties but note that the buyer may bring claims under other relevant warranties. Equally, the notice could “play it safe” by including a long list of potentially relevant warranties, with the buyer narrowing that list down at a later stage.
  • Explain why there has been a breach. This will involve setting out the relevant facts in thorough detail so as to enable the seller to understand the background. The notice should then relate those facts to the relevant provisions of the SPA to explain why they amount to a breach of contract.

Access the court’s decision in Drax Smart Generation Holdco Ltd v Scottish Power Retail Holdings Ltd [2024] EWCA Civ 477 on whether a buyer’s notice of warranty claim complied with contractual requirements