Business sale indemnity did not cover historic damage

The High Court has held that an indemnity in the sale and purchase agreement for a business did not extend to damage to assets that occurred before the parties signed the agreement.

What happened?

Gwynt y Môr OFTO plc v Gwynt y Môr Offshore Wind Farm Ltd [2020] EWHC 850 (Comm) concerned the sale of the business of maintaining and operating the electrical transmission link from the Gwynt y Môr wind farm off the North Wales coast.

The sale took the form of a transfer of all of the assets making up the business. Those assets included a set of subsea export cables.

The sale agreement (SPA) contained an indemnity covering damage to the assets of the business. The indemnity was worded as follows:

If any of the Assets are destroyed or damaged prior to Completion (Pre-Completion Damage), then, following Completion, the [sellers] shall indemnify the [buyer] against the full cost of reinstatement of any Assets affected by Pre-Completion Damage.

The SPA was signed on 11 February 2015 and completed on 17 February 2015. On 2 March 2015, one of the subsea cables failed. On 25 September 2015, another cable failed. The buyer repaired the cables at a cost of £15m.

On inspection, the cause of the failure was identified as corrosion to the cables dating back months or years and caused by damage to the cables’ polyethylene sheath.

The buyer claimed the repair costs from the sellers under the indemnity on the basis that the damage to the cables had occurred before completion.

The sellers rejected the buyer’s claim, alleging that the indemnity only covered damage to assets that occurred between the date on which the SPA was signed (11 February 2015) and completion (17 February 2015), and not damage that had occurred before the parties had signed the SPA.

What did the court say?

The court agreed with the sellers.

The judge acknowledged that the indemnity did not set a “starting point” for the period during which any damage would be covered by the indemnity. It merely referred to damage “prior to Completion”, which would in theory cover the historic damage to the cables.

However, he said it was important to look at the clause as a whole and interpret it at the point the parties signed the SPA. In particular, he focussed on the tense of the verb in the indemnity.

The fact that the parties had used the verb “are” in the indemnity suggested that it was forward-looking and covered only damage that occurred after the SPA was signed. If the parties had intended to cover damage that occurred before the SPA was signed, they would have used the formulation: “If any of the Assets have been damaged or destroyed…”

In fact, he said, even then the indemnity might not have been clear enough to capture historic damage and it might have needed to refer explicitly to damage occurring “before this Agreement”.

Interestingly, the judge also noted that the indemnity appeared in the SPA immediately after the clause dealing with signing and before the clause dealing with completion. This suggested that the indemnity was intended to deal with matters arising between those two events.

Finally, he noted that the SPA already contained a warranty by the sellers confirming there had been no damage to any assets (including the cables). He said this warranty would have been “rendered pointless” if the indemnity effectively covered the same ground. He agreed that sometimes an SPA will contain warranties and indemnities that cover similar ground, but that it would be “remarkable” for the parties so carefully to structure and limit a warranty only to neuter it with an all-embracing indemnity.

What does this mean for me?

The judgment is yet another example of how indemnities are construed by the courts “contra proferentem” (i.e. against the person seeking to enforce them) and illustrates the importance of drafting an indemnity (or, indeed, any contractual provision) carefully within the commercial context of the transaction. Parties need to strike a careful balance between keeping provisions simple and understandable and not skimping on important detail.

When drafting a contractual indemnity on a business sale, it is worth considering the following:

  • What period of time should the indemnity cover? It is best to specify a precise start point and end point. Those could be fixed dates or instead linked to specific events. The more open-ended the “cover period”, the more likely a court is to constrain it by looking at the factual background.
  • What loss is the indemnity seeking to cover? Always consider including specific as well as general language (bearing in mind the eiusdem generis rule) to describe the damage/loss to be covered. Greater certainty can only be to the advantage of both the indemnifier and indemnified.
  • When should the indemnity kick in? It should be clear from what point the indemnity itself becomes active. This might be from the date of the contract or (more commonly on a business purchase) from the date of completion.
  • How does the indemnity sit alongside other contractual provisions? This is not the first case in which a court has interpreted an indemnity alongside contractual warranties (or vice versa). Courts will assume that each provision of a contract has its own purpose and that the parties do not intend to create any unnecessary “overlap”.
  • What is needed to claim under the indemnity? The person giving an indemnity should try to set out what specific evidence of loss needs to be shown before they are required to pay out. This might include damage assessment reports, repair bills or penalty notices.
  • Should the indemnity be phrased as a “covenant to pay”? Recent cases (such as AXA SA v Genworth Financial [2019] EWHC 3376 (Comm)) show that including a covenant to pay a specified or calculable amount, rather than simply an indemnity against damage, can potentially improve the measure of recovery.