Time limit for warranty claim did not apply while earn-out dispute was being determined

01 May 2024

The buyer was effectively able to suspend its warranty claim until the parties had worked through an agreed resolution mechanism for an earn-out payment.

The High Court has held that a time limit for commencing legal proceedings for breach of warranties in a share sale agreement had not begun because the parties were still engaged in a process of agreeing an earn-out payment.

The subject matter of the warranty claim overlapped with matters to be taken into account when calculating the earn-out. The judge held that it was not possible to quantify the warranty claim until the earn-out calculation had been concluded.

The decision was made following a combined application to strike out the buyer’s claim or to obtain summary judgment against the buyer. It does not, therefore, set any precedent, but it is nonetheless a useful insight into the court’s thinking.

What happened?

Onecom Group Ltd v Palmer [2024] EWHC 867 (Comm) concerned the sale of shares in a group of telecommunications services companies by an individual to a trade buyer.

The terms of the sale were set out in a sale and purchase agreement (SPA).

For the purposes of the sale, the parties decided to value the business based on a multiple of EBITDA. However, they were unable to reach full agreement on the appropriate EBITDA figure.

The parties therefore included an earn-out mechanism in the SPA. Under that mechanism, an additional payment would be due to the seller if the business performed above a predetermined level during the year following completion of the sale.

If the parties were unable to agree the amount of the earn-out payment, they would refer the matter to an independent expert. In the event, this is what happened, and the parties engaged an independent expert to determine the amount of the earn-out payment.

As is customary, the SPA contained a suite of warranties relating to the target business. It also contained limitations on the seller’s liability for breach of warranty, which included the following provisions.

  • The buyer had 24 months from closing to notify the seller of a potential warranty claim (the notification period).
  • The buyer then had six months from giving notice of a warranty claim to initiate legal proceedings for breach of warranty (the litigation period).
  • If a warranty claim were contingent or incapable of being quantified, the seller would not be liable to make any payment until its liability became actual and quantified.

The buyer identified what it believed were several breaches of warranty and notified them to the seller within the 24-month notification period.

The buyer noted that it then had six months to commence litigation. However, it also noted that several of the matters that formed the basis for its warranty claims also fed into the calculations for the earn-out payment under the SPA. It said its warranty claims were therefore contingent and unquantifiable until the independent expert rendered its determination.

The buyer suggested that the parties extend the litigation period to give the independent expert time to determine the amount of the earn-out payment. In the end, the parties did not reach agreement on an extension period.

The buyer commenced legal proceedings on 21 December 2022, one day before the litigation period ended, giving a best estimate of its claim in its claim form. However, it applied for an extension to the time for serving the claim form on the seller to 31 August 2023.

Around six months later, on 7 June 2023, the independent expert issued its determination. Following this, the buyer wrote to the seller confirming that it had been able to quantify its warranty claims.

On 2 August 2023, the buyer served its claim form on the seller. On 9 November 2023, the buyer issued a further claim form, effectively replacing its best estimate of loss with a final claim figure.

The timeline can be summarised as follows.

The seller claimed that the buyer was “out of time”, because proceedings based on the final figure claimed by the buyer had not been commenced within the litigation period (i.e. within six months of the buyer’s initial notification to the seller).

The buyer claimed that its claim was made within the litigation period, because, until the independent expert rendered its determination, its claim was contingent and unquantifiable.

Upon the expert’s determination, the buyer’s claims became actual and quantified. As a result, the buyer argued, the litigation period began on the date of the independent expert’s determination. As the buyer had served its original claim form, and both issued and served its revised claim form, within six months of that determination, it was not “out of time”.

What did the court say?

The court agreed with the buyer.

It was not possible to know the amount of the buyer’s claims until the independent expert reached its determination. Until that happened, the claims were contingent and unquantified. Under the terms of the SPA, the litigation period did not begin until they became actual, quantified claims.

The court rejected the seller’s argument that the SPA merely required the buyer to be able to make an “assessment” of how the claim would be quantified at the end of the dispute. If this is what they had intended, the SPA would have stated this. However, it referred only to a “quantified” claim.

The judge was also persuaded by the argument that requiring the buyer to commence and perhaps even conclude proceedings for breach of warranty could lead to “double recovery” if the buyer then recouped those same losses through the calculation of the earn-out payment.

In that context, it was more logical for the deadline for the buyer to bring its warranty claims to be postponed until after the earn-out calculation had been determined.

What does this mean for me?

The decision shows the importance of ensuring that, on a share or business sale, it is clear how the warranty provisions (including limitations on liability) and any consideration adjustments are intended to interact.

This particular case centred around the calculation of an earn-out payment, but the same principle might equally apply to a completion accounts or other purchase price adjustment mechanism.

A seller should also guard against the risk of the buyer recovering more than once by ensuring that, where credit or compensation is provided through a purchase price adjustment, the buyer is not also able to bring a warranty claim to recoup the same amount again.

Access the court’s decision in Onecom Group Ltd v Palmer [2024] EWHC 867 (Comm) on whether a time limit applied to a warranty claim while an earn-out payment was being determined