Corporate Law Update

• The High Court considers multiple warranty claims under a share purchase agreement, disallowing two, allowing one, and ruling on time limits and quantum (update, part 2)
• The Association for Financial Markets in Europe publishes revised selling restrictions wording for issuers of securities to cater for the UK leaving the EU
• The European Securities and Markets Authority publishes new Q&A on the EU Prospectus Regulation
• Other items of interest

Court considers multiple warranty claims under share purchase agreement (continued from last week)

Last week we looked at the recent case of Triumph Controls v Primus International, in which the High Court considered multiple warranty claims under a share purchase agreement (SPA). In particular, we looked at whether the buyer (Triumph) had validly notified the seller (Primus) of warranty claims.

This week, we examine two of the warranty claims in detail. Next week, we will look at the third warranty claim and at how the court decided to calculate the damages owed to Triumph.

What happened?

As we noted last week, Triumph acquired the shares in three subsidiaries from Primus. Those subsidiaries together comprised Primus’ composites manufacturing division in the UK and Thailand.

The SPA contained standard provisions, including numerous warranties about the state of the subsidiaries and their business.

After the deal completed, the subsidiaries’ financial and operating position deteriorated rapidly. In particular, according to Triumph, operational issues at the UK site led to a significant shortfall in revenue, and numerous other issues caused the financial performance of the business to perform significantly worse than forecast. Finally, seven months after the sale completed, the business lost its “Nadcap” industry accreditation, which it needed to continue operating.

According to Triumph, the value in the shares in the subsidiaries was completed wiped out, rendering them “worthless”.

Triumph brought claims against Primus for breaches of eight different warranties. The court grouped those claims into three categories:

• Claims in relation to the loss of the subsidiaries’ Nadcap accreditation.
• Claims in relation to operational issues.
• Claims in relation to forward-looking projections.

The court examined each group of claims separately and reached a different conclusion in each case. We examine the court’s decision on the first two categories of claim below.

We examine the court’s decision on the first two categories of claim below.

The Nadcap claims

In the SPA, Primus warranted that the subsidiaries had all “licences, consents, permits and associated registrations and authorities” necessary to carry on their business (which, for ease, we will refer to simply as “permits”), and that the subsidiaries had materially complied with those permits. 

In 2012 and 2013, the business underwent issues in relation to its Nadcap accreditation:

• In late 2012 (before the sale completed), an external audit revealed nine instances of non-compliance. The business submitted an action plan and accreditation was renewed.
• However, the next external audit in late 2013 revealed nine issues, including six major issues. The business failed the audit and its Nadcap accreditation was revoked.
• In early 2014, the businesses passed an interim audit with no negative findings.
• Nadcap accreditation was re-issued with effect from August 2015. 

Triumph said Nadcap accreditation was a “permit”, and that it was needed to carry on the business, as major customers would not deal with the subsidiaries unless they were accredited. It also said that the subsidiaries had not been materially compliant with that accreditation when the deal closed in 2013, and their failure to address this non-compliance led directly to the loss of accreditation in 2013.

Primus said that Nadcap accreditation was not a “permit”, because the subsidiaries were not required by law to hold accreditation to carry on their business. It was merely an industry scheme operated by a third party, and the subsidiaries were able to carry on business without it. In any case, the subsidiaries were compliant when the deal closed, and accreditation was only lost after Triumph had taken control.

The court had to answer two broad questions:

• Was Nadcap accreditation a “permit”? This was a question of interpreting the contract.
• Was the business non-compliant in 2012, and did this lead to loss of accreditation in 2013?

We now have a wealth of recent cases that tell us how courts will interpret contracts, including Arnold v Britton, Rainy Sky v Kookmin Bank, Chartbrook v Persimmon and Wood v Capita. The court drew on these cases to decide whether the parties intended the concept of a “permit” to include Nadcap accreditation.

Interestingly, the court decided that Nadcap accreditation was a permit. It allowed the business to hold itself out as compliant with certain standards. This permission fell within the “ordinary and natural meaning” of the words “permit” and “licence”. It also said that, although accreditation was not a legal requirement, major customers would not trade with the business unless it held accreditation. It was therefore required for the business to carry on as it had done.

However, the court did not agree that the business was non-compliant. There had been systemic non-conformity in quality processes, but this did not mean accreditation had been breached. At the point of closing, the business had done enough to retain accreditation.

The claim therefore failed.

The operational issues claims

Primus warranted in the SPA that it was not aware of any matter that might give rise to litigation, nor of any circumstances that might result in a material claim in relation to supplies by the business. Finally, it warranted that the subsidiaries had not breached any material contracts.

Triumph claimed that the businesses had been suffering operational failings that amounted to breaches of material contracts and could give rise to claims, and that Primus knew this.

In response, Primus said it had disclosed the failings to Triumph.

It is generally accepted that, under English law, a buyer cannot bring a warranty claim if it knew about the breach when it entered into the contract (Eurocopy v Teesdale), although it may be possible to modify this in the contract (Infiniteland v Artisan Contracting).

However, it can be difficult to show whether a buyer knew about something before signing the contract. An SPA therefore usually includes a mechanism allowing the seller to “disclose” issues that contradict the warranties. A buyer cannot bring a warranty claim in relation to a disclosed matter. The SPA will usually state the level of detail required for a disclosure. Often it will require disclosure to be fair and sufficiently detailed for the buyer to identify the nature and scope of the matter in question.

A seller normally makes disclosures in a separate “disclosure letter”. Disclosures can be “specific”, where the seller draws special attention to an issue, or “general”, where the seller makes documents available generally and states that their contents will be deemed disclosed.

The courts have also given guidance on disclosure. Generally, disclosure is effective only if it is “fair”. The disclosure must allow the buyer to reach conclusions for itself (Levison v Farin), and decide whether to exercise its contractual rights (Edward Prentice v Scottish Power). However, disclosure is unlikely to be fair if it simply refers to a complex body of information, instead of drawing the matter out specifically (New Hearts v Cosmopolitan Investments), or if the matter in question is not apparent from the documents that have been provided (Man Nutzfahrzeuge v Freightliner).

In this case, the SPA required Primus’ disclosures to be “fairly and clearly disclosed … with sufficient detail to identify the nature of the matter disclosed”.

In its disclosure letter, Primus referred to specific operational issues under contracts with three major customers, including potential disputes and delivery penalties. It also made a general disclosure of the entire electronic transaction data room, which contained (among other things) briefing notes and metrics that identified increasing customer arrears.

The judge said that these specific and general disclosures were effective, meaning that Primus was not liable under the warranty claim. Her comments on whether Primus’ disclosure was adequate are interesting. She said the following:

• The SPA allowed disclosure to be made “in or under” the disclosure letter. This meant the letter did not have to set out every warranty breach expressly, and that, given the scale of the business, this was a “sensible and practical approach”.
• Primus had effectively disclosed the entire data room. It was clear Triumph had agreed to this, particularly because the data room had been provided on-line, and both parties had initialled an index and attached it to the disclosure letter. Triumph could still argue that a particular document in the data room didn’t “fairly disclose” an issue, but it had accepted general disclosure of the data room “as a matter of principle”. Again, the judge said that was a “sensible and practical approach”, given the volume of documentation.
• The SPA required the nature of any matters to be disclosed, but it didn’t require the seller to give details of the extent or scope of the matter. Triumph argued that the documents Primus had disclosed didn’t reveal the full scale of the problem, but the court said this was irrelevant. The SPA didn’t require Primus to spell out the full extent of any issues.

Again, the claim failed.

How does this affect me?

The Nadcap claim is a good example of how the courts can take a more expansive approach when interpreting warranties. The Nadcap accreditation was not a “licence” to carry on component manufacturing, but it was a licence for the business to represent itself as being accredited to a given standard. That was enough for the warranty to bite (although, on the facts, there was no breach).

Sellers should ensure warranties are worded carefully and make it clear whether a warranty is to cover purely legal and compliance requirements or to extend more broadly to commercial matters.

The judge’s comments on disclosure are particularly interesting. A seller needs to judge carefully how much detail to include on a disclosure. Management will typically want to ensure time devoted to disclosure is proportionate to their other demands during the sale process, but in doing so there is a risk that disclosures will lack enough detail to be considered “fair”.

One way to tackle this is to disclose the entire deal data room, and this approach is now relatively widespread in the UK. However, it is unclear whether this kind of disclosure is always effective, such as where a seller attempts a “data dump” by disclosing a significant volume of information to a buyer.

This case gives comfort that disclosure through a data room is perfectly legitimate where a large volume of documentation is involved. However, disclosure in this way will still need to be “fair”. It is unlikely that information contained in some obscure part of a document, or in some unrelated section of a data room, will be fairly disclosed.

With this in mind, a seller looking to disclose against warranties should consider the following:

• What standard of disclosure does the SPA require? Is it enough simply to refer to the matter, or should the disclosure contain further information, such as estimates and specific details.
• In any case, is the disclosure likely to be fair? Does it contain enough information to enable the seller to appreciate the significance of the matter and decide what to do in response?
• If the seller is proposing to disclose the data room, does the disclosure letter make it clear what precisely is being disclosed? Best practice would be to include a copy of the data room on an electronic storage medium (such as a flash drive) and to append a copy of the index to the letter.
• Has the data room been properly structured? If it contains information the seller needs to disclose against the warranties, is that information located in a logical part of the data room where a buyer would expect to find it? Has the seller drawn the buyer’s attention to that information by referring to the specific section of the data room in its disclosure letter?

AFME publishes post-Brexit equity selling restriction wording

The Association for Financial Markets in Europe (AFME) has published revised wording for the selling restrictions most commonly put in place on equity transactions. The new wording is designed to be used after the United Kingdom leaves the European Union (EU).

The purpose of selling restrictions is to give comfort to an issuer that any shares placed by or with its underwriters will not be offered in breach of the EU Prospectus Directive.

The new draft wording covers two different scenarios:

• Where the UK leaves the EU without a deal (“no-deal Brexit”). AFME has provided two separate formulations – one for offers made within the European Economic Area (EEA), and one for offers made within the UK.
• Where the UK leaves the EU with a transitional (withdrawal) agreement. This is a single formulation for offers made across the EEA and UK.

In both cases, the wording assumes that the UK neither continues automatically as a member of the EEA on Brexit (although there remains some debate on this question) nor re-joins the EEA after Brexit.

The wording reflects the current regime under the EU Prospectus Directive. On 21 July 2019, the Directive will be replaced by the EU Prospectus Regulation. On a no-deal Brexit, the Government is proposing to “on-shore” the Prospectus Regulation into UK law using secondary legislation. AFME has said it will publish revised wording once the timing of this on-shoring is finalised.

ESMA publishes new Q&A on the EU Prospectus Regulation

The European Securities and Markets Authority (ESMA) has published a new Q&A document on the EU Prospectus Regulation.

Most of the Q&A deal with the transition from the current regime under the EU Prospectus Directive (the “old regime”) to the new regime under the EU Prospectus Regulation. In particular:

• Advertisements for securities approved under the old regime will, from 21 July 2019, need to comply with the new regime.
• Likewise, a registration document previously approved under the old regime will need to be re-approved under the new regime. However, broadly speaking, it should be possible to incorporate information by reference to a registration document approved under the old regime.
• Conversely, it will generally still be possible to passport and supplement a prospectus approved under the old regime until it expires. However, this will need to be done according to the local law of the state in which the prospectus was approved, not under the new regime.
• The old ESMA Q&A on the Prospectus Directive and the ESMA Update of the CESR Recommendations will apply to prospectuses under the new regime to the extent they are not incompatible with the Prospectus Regulation.

ESMA will update the Q&A document from time to time. It will also accept additional questions on the Prospectus Regulation through its website.

As noted above, the Prospectus Regulation is due to come into effect on 21 July 2019, although some discrete provisions came into effect on 21 July 2017 and 21 July 2018. In the event of a no-deal Brexit, the Government is currently intending to on-shore the Prospectus Regulation into UK law using secondary legislation. However, whilst the ESMA Q&A would no doubt be influential under the proposed on-shored regime, they would not have any binding status in the UK following Brexit.

Other items

• Capital markets. ESMA has published final guidelines on risk factors under the new EU Prospectus Regulation. The guidelines are designed to assist EU competent authorities with assessing whether risk factors included in securities prospectuses are limited to those which are specific and material and are properly presented. Although the guidelines are addressed to EU financial authorities, they will also be helpful for issuers when ensuring that any prospectus they draw up complies with the Regulation’s requirements for risk factors.
• Capital markets. ESMA has also published its final technical advice on the minimum information content for a prospectus exemption. Under the EU Prospectus Regulation, an issuer does not need to publish a prospectus when it offers shares in connection with a takeover, merger or division, provided it publishes an equivalent document that contains a minimum level of information. The prescribed content is set out in an annex to the technical advice document.
• Corporate reporting. The Government has published guidance to assist companies and limited liability partnerships (LLPs) with their new emissions and energy usage reporting obligations under the Companies (Directors' Report) and Limited Liability Partnerships (Energy and Carbon Report) Regulations 2018. The Regulations apply to financial years beginning on or after 1 April 2019.
• Market abuse. ESMA has updated its Q&A on the Market Abuse Regulation (MAR). ESMA has clarified that collective investment undertakings (CIUs) that do not have legal personality can be issuers and so are required to disclose inside information to the market. It has also given examples of situations that could give rise to inside information relating to a CIU. Finally, ESMA has also added two new Q&A relating to emissions allowances.
• Auditing. The Business, Energy and Industrial Strategy Parliamentary Select Committee has published a report on the future of audit. Recommendations include requiring companies to state their level of distributable profits in their accounts, adopting a solvency statement-based approach for declaring company dividends, full legal separation of audit and non-audit services, and increasing the frequency of auditor rotations from every ten years to every seven years.