Corporate Law Update

• The court interprets the meaning of “goodwill” in an exclusion of liability for lost goodwill arising from a breach of warranty
• Further model environment-conscious drafting is published as part of the Climate Contract Playbook
• The Takeover Panel confirms that it will be consulting soon on amending the Takeover Code to accommodate regulatory clearances
• The European Securities and Markets Authority publishes a review and recommendations on the Market Abuse Regulation
• The European Commission publishes its second action plan on the EU Capital Markets Union
• The International Corporate Governance Network publishes a revised version of its Global Stewardship Principles

Covid-19 is affecting the way people conduct their business, retain their staff, engage with clients, comply with regulations and the list goes on. Read our thoughts on these issues and many others on our dedicated Covid-19 page.

Warranty claim was not prevented by exclusion of loss in goodwill

The Court of Appeal has held that a claim for breach of warranty relating to forecasted earnings was not prevented by a clause excluding the seller’s liability for “lost goodwill”.

What happened?

Primus International Holding Company v Triumph Controls UK Ltd [2020] EWCA Civ 1228 concerned an appeal from a previous decision of the High Court concerning claims relating to the sale of two aerospace manufacturing companies by Primus to Triumph. Primus gave various warranties as to the state of the business run by the two companies in the share sale agreement (SPA).

In brief, shortly after acquiring the companies, the financial and operating position of the business deteriorated rapidly. Triumph brought proceedings against Primus for breach of various warranties.

We previously covered the High Court’s decision in a series of three Corporate Law Updates. You can read the background to the claim in our Corporate Law Update from 29 March 2019. (You can read about the other matters in dispute between the parties in our Corporate Law Update from 5 April 2019 and our Corporate Law Update from 12 April 2019.)

Among other things, Triumph claimed that Primus had breached a warranty that certain forward-looking projections – known as the “Long Range Plan” – had been “honestly and carefully prepared”. The High Court judge agreed that the warranty had been breached and awarded Triumph damages.

Primus appealed. It argued that, notwithstanding the breach of warranty, Triumph could not recover its loss because the SPA specifically excluded Primus’ liability for a warranty claim “to the extent that … the matter to which the claim relates … is in respect of lost goodwill”. The loss Triumph had suffered, Primus argued, was solely loss of goodwill.

To decide whether the exclusion applied, the court had to work out the meaning of the word “goodwill” in the SPA.

Primus argued that “goodwill” referred to “an intangible asset recorded when a company acquires another company and the purchase price is greater than the sum of the fair value of the identifiable tangible and intangible assets acquired”. This definition derives from accounting standards and effectively reflects the difference between the purchase price and the net asset value.

Because the loss Triumph had suffered was not referable to any particular assets, Primus argued that it must, by definition, be referable to “goodwill” and so was not recoverable.

Triumph, on the other hand, argued that “goodwill” simply meant the “good name, business reputation and connections of a business”, rather than any value over and above the purchase price. The loss suffered was, Triumph argued, referable to forecasted future performance – that is, anticipated revenue streams – rather than name and reputation.

What did the court say?

The court agreed with Triumph’s interpretation.

Essentially, the question before the judges was one of contractual interpretation. The court drew on the principles set out by the Supreme Court in the now well-known trio of cases: Rainy Sky S.A. v Kookmin Bank [2011] UKSC 50, Arnold v Britton [2015] UKSC 36 and Wood v Capita Insurance Services Ltd [2017] UKSC 24.

However, the judges noted that this case was unusual, because neither Primus nor Triumph had relied on any pre-contract negotiations or other factual context to back up their arguments. The court therefore had to examine the language of the SPA alone to determine the parties’ intentions.

The judges gave several reasons for preferring Triumph’s interpretation:

• The ordinary legal meaning of the word “goodwill” is the good name and public reputation of the business concerned. There was no reason for the court to depart from that ordinary meaning in this particular case. If Primus and Triumph had intended to use a technical accounting definition, they would have spelled that out, but they hadn’t.
• This interpretation was backed up by previous court decisions, which had concluded that goodwill included the “benefit and advantage of the good name, reputation and connection of a business”, as well as an “agreed absence from competition”. None of those authorities pointed towards the technical, accounting sense of the word.
• Other parts of the SPA used the term “goodwill” to refer to the companies’ name, reputation and business connection. This was particularly apparent in the non-compete covenants in the SPA, which were intended to protect that reputation.
• Those covenants also referred to future as well as present value, which was inconsistent with an accounting term that would require the business to be valued at the date of the sale. If “goodwill” meant only the value on sale, there would have been no need for covenants protecting goodwill in the future.
• Perhaps most convincingly, the court noted that several warranties in the SPA did not refer to the value of assets, such as those concerning the accuracy of the companies’ registers and compliance with licences. If Primus’ interpretation of “goodwill” had been correct, all claims would have been excluded except those relating to the value of identifiable assets. This would have neutered several warranties, or at least have required them to be phrased very differently.

As a result, the exclusion did not apply and Triumph’s claim was preserved.

What does this mean for me?

This is another salutary warning to contract parties to use specific language, particularly when attempting to limit or exclude liability. If there is any ambiguity, the courts will always construe a limitation or exclusion clause against the party who is seeking to benefit from it (“contra proferentem”).

In our experience, it is not common for a seller to succeed in excluding liability for any lost goodwill on a share sale. This will have done little to help Primus’ case, as there is little or no precedent for interpreting the term in the context of a limitation of liability in connection with a share sale.

The interpretation Primus had argued for was based on well-trodden principles. The accounting sense of “goodwill” is widely understood and plays an important role when valuing a business that is being bought or sold. But it should not be assumed that this definition will automatically track across into a commercial contract. Fatally for Primus’ case, applying the accounting definition in this case would effectively have nullified many of Triumph’s protections in the SPA, which made no commercial sense.

Further environment-conscious drafting published

The Chancery Lane Project, a pro bono collaboration involving lawyers working at various UK firms (including Macfarlanes) to develop new contracts that recognise climate concerns, has published the third edition of its Climate Contract Playbook.

The Playbook contains 50 template clauses for different types of commercial contract, which can be used by businesses, communities and legal advisers. Each clause bears a child’s name as a reminder of the importance of the climate to future generations.

The model clauses in the Playbook include the following, which may be of use in commercial and corporate contracts:

• Clauses for an investment or shareholders’ agreement designed for green investment objectives.
• Warranties relating to emissions data for a commercial contract or a share/business sale agreement, along with a liquidated damages clause.
• Provisions for a company’s constitution setting out an environmental purpose for the company.
• Warranties for an underwriting or sponsor’s agreement confirming that the issuer has complied with environmental laws and assessed its carbon footprint.
• Due diligence questions and convertible loan notes designed with a “net zero” objective in mind.
• Wording for board minutes to show that directors considered environmental factors when taking a decision.
• A statement in heads of terms that parties intend to pursue a transaction in an environmentally-conscious way.
• Rights for a customer to end a supply contract in order to switch to a greener supplier.
• Obligations on a supplier to align its net zero target with its customer’s and to meet certain environmental performance standards, including in relation to single-use plastic.
• Wording for green loans and sustainability-linked loans.

The model clauses are free to use. They are untailored, so businesses and legal advisers should exercise judgment when deciding how and when to use them.

Also this week…

• Takeover Panel to consult on offer conditions and timetable. The Takeover Panel has published its 2019/2020 annual report and accounts, setting out its activities during the last financial year. Among other things, the report confirms that the Panel intends to publish a consultation paper shortly on better accommodating the need for official authorisations and regulatory clearances on a takeover bid.
• ESMA publishes first full review of MAR. The European Securities and Markets Authority (ESMA) has published a final report following its first review of the EU Market Abuse Regulation (MAR). The report contains proposals for refining the EU market abuse regime. These include providing more clarify around what constitutes “inside information”, when disclosure can be delayed and how insider lists should be kept, as well as further exemptions from the prohibition on managers trading in their issuer’s shares during a “closed period”. Although MAR will continue to apply (in a modified form) in the UK once EU law ceases to apply, any changes arising from ESMA’s report will not occur until 2021 at the earliest and so will not track through into the UK version of MAR. It will be for the Financial Conduct Authority to decide whether to implement similar changes in the UK.
• EU publishes second action plan on Capital Markets Union. The European Commission has published its second action plan on the European Union’s Capital Markets Union (CMU). The plan sets out 16 key measures designed to complete the CMU. These include simplifying the listing rules and creating a single rulebook for EU capital markets, and creating an EU-wide platform for access to issuer information.
• ICGN publishes revised Global Stewardship Principles. The International Corporate Governance Network (ICGN) has published a revised version of its Global Stewardship Principles. The revised version can be found as an annex to the ICGN’s 2000 AGM papers.