Corporate Law Update
- The Court of Appeal analyses the scope of an indemnity in a share sale agreement (and overturns the High Court’s decision)
- The Financial Reporting Council publishes a report on workforce-related corporate disclosures
- The PLSA publishes its 2019 AGM voting review
The Court of Appeal has reversed a decision by the High Court about the extent of an indemnity in a share sale agreement, showing the need to take care when drafting reimbursement provisions.
We looked at the High Court’s decision in Al-Hasawi v Nottingham Forest Football Club  EWHC 1287 (Ch) in a previous Corporate Law Update. The Court of Appeal has now examined an appeal from that decision (Al-Hasawi v Nottingham Forest Football Club Ltd  EWCA Civ 2242).
The case concerned the sale of Nottingham Forest F.C. (the Club) by Mr Fawaz Al-Hasawi to Mr Evangelos Marinakis in May 2017. The transaction was structured as a sale of the shares in the company that operates the Club. The shares were sold by a company controlled by Mr Al-Hasawi (the seller) to a company controlled by Mr Marinakis (the buyer).
The share sale agreement (SPA) contained a bespoke term requiring the seller to indemnify the buyer for all “Liabilities” above £6.6 million as at 31 December 2016. That figure was derived from a trial balance setting out the Club’s assets and liabilities as at that date. The purpose of the indemnity was to ensure that the buyer did not have to bear the economic burden of any undisclosed liabilities.
The SPA defined “Liabilities” in some detail, setting out examples of items that fell within the definition and some items that had been specifically excluded. In particular, it stated that they included “all liabilities in respect of any fact, matter or circumstance on or prior to [31 December 2016] (and only to the extent such liabilities relate to such period)”.
In October 2017, the buyer brought a claim against the seller under the indemnity. The question for the court was how to interpret the defined term “Liabilities”.
The buyer said the term was intended to reflect the definition of “liabilities” in Financial Reporting Standard 102 (FRS 102), the basis on which the trial balance had been prepared. FRS 102 requires a company to recognise liabilities on an “accruals basis”. This requires a company to book liabilities in the accounting period in which they are incurred, not when they are discharged.
The seller said that, by including the words “and only to the extent such liabilities relate to such period” (i.e. the period before 31 December 2016), the parties had clearly intended to depart from FRS 102. Those words were clearly designed to exclude any liabilities arising after 31 December 2016, even if they had been incurred before that date. This approach was inconsistent with FRS 102.
If the buyer was right, the Liabilities exceeded £6.6m and the buyer was entitled to reimbursement. If the seller was right, the Liabilities were below £6.6m and the buyer had no claim.
What did the court say?
Initially, the High Court agreed with the seller. The judge said that the definition of “Liabilities” in the SPA was “bespoke” and worded differently from that in FRS 102.
To conclude that the two were the same, he would effectively have had to decide that the words “and only to the extent such liabilities relate to such period” were simply “surplusage” with no meaning that had resulted from “zealousness” by the people drafting the SPA. He was not prepared to do this, preferring to give the words some effect if possible.
This interpretation, according to the judge, fulfilled the indemnity’s purpose: to ensure that any benefits and liabilities arising after 31 December 2016 were attributed to the buyer, not the seller.
However, the Court of Appeal disagreed. The three judges unanimously agreed that the term “Liabilities” was to be interpreted consistently with FRS 102. The court gave the following reason:
- The purpose of the indemnity was not to apportion liabilities between the buyer and seller, with 31 December 2016 as the dividing line. Rather, it was to underpin the Club’s valuation and rectify matters if the buyer ended up having to commit more finance than the trial balance suggested.
- For the indemnity to achieve this, the buyer had to be able to compare the total “Liabilities” with the trial balance in order to calculate any excess or shortfall. Realistically, it could do this only if the term of “Liabilities” was read in the context of FRS 102. Otherwise, the parties would not be comparing “like for like”.
It therefore overturned the High Court’s decision and found that the buyer did have a good claim.
What does this mean for me?
When it comes to cases about interpreting indemnities, we have been spoilt for choice recently. Almost three years ago, the judgment in Capita v Wood  UKSC 24 showed us how important a comma can be, in that case substantially affecting the breadth of an indemnity against fines by the FCA.
Only last week we reported on the case of AXA v Genworth  EWHC 3376 (Comm), in which the court found that an obligation phrased as a “covenant to pay” rather than an “indemnity” gave the buyer a greater measure of recovery.
And in Hopkinson v Towergate  EWCA Civ 2744 and First Names v IFG Group  EWHC 3014 (Comm), the buyer’s ability to bring a claim under an indemnity depended heavily on how claims notice provisions and related definitions had been drafted. (See our previous Corporate Law Updates here and here respectively for more information.)
This run of cases shows how important it is to pay attention to the drafting of any indemnities or compensation mechanisms. In particular, it is worth bearing the following in mind:
- In most cases, an indemnity will be more effective for a buyer if it is phrased as a covenant to pay and is linked to an underlying event, rather than a breach of contract. This will avoid the clause being construed as a simple indemnity for loss (which does not provide pound-for-pound recovery) or a liquidated damages clause (which could amount to an unenforceable penalty).
- Make the commercial rationale for the indemnity clear. Often this will be apparent from the context, although it may be worth including some brief language in the contract recitals, or even in the indemnity itself, to set out the background to the provision. This may help guide the courts should they need to interpret the indemnity.
- Ensure that the indemnity ties in properly with other parts of the agreement. Claims can fail not due to an indemnity itself, but because of how related definitions are drafted or the way in which the indemnity intersects with the liability limitations and claims notice provisions.
- FRC publishes report on workforce reporting. The Financial Reporting Council’s Financial Reporting Lab has published a report on workforce-related corporate reporting. The report highlights demands by investors, regulators and society in general for more detailed, transparent disclosure of workforce matters. It provides guidance on how to structure workforce disclosures in the form of questions to ask and examples of disclosures and approaches.
- PLSA publishes 2019 AGM voting review. The Pensions and Lifetime Savings Association has published its annual review of voting at annual general meetings of FTSE 350 companies. The main purpose of the review is to identify principal areas of shareholder dissent. It states that, in 2019, 148 AGM resolutions proposed by 81 companies attracted dissent levels of over 20%, an almost identical level to that in 2018. Key areas of dissent included director remuneration, elections and re-elections.