Corporate Law Update

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• Warranty claim notice should have identified breached warranties
• PSC regime for foreign companies by early 2021
• Sole foreign subsidiary did not prevent cross-border merger after all 

Warranty claim notice should have identified breached warranties

The Court of Appeal has said that a warranty claim notice under a share sale agreement was not valid because it did not specifically identify the warranties alleged to have been breached.

What happened?

In Teoco UK Limited v Aircom Jersey 4 Limited and another, Teoco bought the shares in two companies from Aircom.

In the sale agreement, Aircom warranted that the target companies had paid all tax due. It also gave a tax covenant to Teoco, promising to pay any outstanding tax liabilities relating to the target companies.

The sale agreement required any notice of a claim by Teoco under the warranties to set out reasonable details of the claim, including the grounds of claim. Finally, the sale agreement set out a deadline for Teoco to bring warranty claims, after which Aircom would not be liable for breach of the warranties.

In short, around five months before the claims deadline, Teoco sent a letter to Aircom claiming breaches of the tax warranties. It sent another letter to Aircom a month before the deadline providing more information on its claim.

Both letters stated that they were notices, under the sale agreement, of a claim for breach of warranty or a claim under the tax covenant. Each letter set out details of the facts that Teoco alleged amounted to breaches of the warranties. However, neither letter identified the specific warranties that Aircom was alleged to have breached, nor the specific parts of the tax covenant that had been triggered.

What did the court say?

In the initial hearing in the High Court, the judge said that neither letter was a valid claim notice. He said that the generic reference to the tax warranties and tax covenant was “not nearly sufficient to inform the Sellers . . . of what they had done wrong and what consequences flow”.

The letters did not therefore satisfy the requirement in the sale agreement to set out reasonable details of the claims or the grounds on which they were based. In reaching this decision, the court relied heavily on the previous decision in RWE Nukem Ltd v AEA Technology plc.

The Court of Appeal upheld the High Court’s decision. It found that the failure to identify the specific warranties and parts of the tax covenant was fatal to the claims notices and rendered them invalid.

Practical implications

The judgment simply confirms the original decision but reminds us how critical it is to frame a warranty, indemnity or tax covenant claim correctly.

Ultimately, this will always depend on the wording of the sale agreement and, if that wording is unclear, what the court believes the parties intended. We already know from RWE Nukem that it is not always necessary to cite each relevant individual warranty or part of a covenant. We also know from Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd that a notice can be valid even if it refers to the wrong warranty.

However, a notice will be valid in these scenarios only if it makes the grounds of claim very clear. The combined effect of RWE Nukem and Teoco shows the critical importance of setting out the precise contractual grounds of claim, including the warranties in question.

If drafting a notice of warranty, indemnity or covenant claim, it is important to review the terms of the sale agreement carefully and consult a lawyer. In particular, a buyer should take the following steps:

• Include as much detailed background of the facts giving rise to the claim as possible to ensure that the notice contains reasonable details and grounds for bringing the claim.
• Refer specifically to each warranty, indemnity or tax covenant provision under which the buyer will, or may wish, to claim.
• Ensure the notice is delivered to each and every person entitled to receive notice (as shown in Zayo, which we looked at here) using a method set out in the sale agreement, and keep evidence of delivery.
• Follow up by starting legal proceedings within the deadline (if any) in the sale agreement, and ensure that the grounds of claim match those set out in the initial claim notice.

PSC regime for foreign companies by early 2021

The Department for Business, Energy and Industrial Strategy (BEIS) has announced that the proposed new overseas entity beneficial ownership (OEBO) regime will go live by early 2021.

Under the new OEBO regime, which is likely to be similar to the UK’s existing persons with significant control (PSC) regime, overseas companies will need to register details of their beneficial ownership in certain circumstances. These include where the companies wish to acquire or continue to hold real estate in the UK or enter into a public procurement process in the UK.

The Government intends to publish draft legislation this summer and introduce it into Parliament by next summer. BEIS has also confirmed it will respond to its November 2016 call for evidence shortly.

For more information on that call for evidence and the OEBO regime generally, see our update here.

Sole foreign subsidiary did not prevent cross-border merger after all

The Court of Appeal has decided that it is possible to include a single overseas company in a cross-border merger purely in order to introduce a cross-border element.

What happened?

The European Cross-Border Mergers Directive (the “Directive”) created a mechanism by which companies in different European Economic Area (EEA) states can “merge”. The UK has implemented the Directive through the Companies (Cross-Border Mergers) Regulations 2007 (the “Regulations”).

To be valid, a cross-border merger must have a “cross-border element”. In other words, it must involve companies from two or more EEA states. It is not possible, for example, to use the regime to merge one UK company into another UK company.

In Easynet Global Services Ltd v Secretary of State for Business, Energy and Industrial Strategy, Easynet proposed to merge 22 subsidiary companies into a single UK company.

All of the companies involved in the merger were UK companies, except for one, which was a dormant Dutch subsidiary that had never traded. Easynet acknowledged that the only reason for including the Dutch company in the merger was to introduce a cross-border element.

What did the court say?

At the first hearing in the High Court, the judge said that the Dutch company was a mere “device” and did not fit with the original purpose of the Directive. He said that the scheme was not in reality a “cross-border merger” and refused to sanction it.

Easynet appealed to the Court of Appeal.

The Court of Appeal decided that the merger was valid. It said that the cross-border regime had been created to promote freedom of establishment, one of the four fundamental freedoms under EU law.

There was nothing in the Directive or the Regulations allowing the court to reject a proposed merger because it did not lack a “real” cross-border element. The Court felt that introducing this test would create a material restriction on the right of freedom of establishment.

The Court also said that including the dormant Dutch company in this manner did not amount to an abuse of EU law.

Practical implications

Whether right or wrong, the decision in Easynet is certainly helpful. Although somewhat bureaucratic, the cross-border merger procedure is relatively simple. It can often have tax advantages, as in the Easynet case, and it avoids the need to appoint a liquidator to wind the merging companies up.

The original decision in Easynet curtailed the prospect of using the mechanism. However, the Court of Appeal’s decision restores its wide flexibility and scope.

Easynet now suggests that the regime could be used to carry out a substantially domestic merger, provided one company from another EEA state is involved. This may provide flexibility for businesses looking to conduct large-scale group reorganisations and to deal simply with defunct companies.