Court interprets knowledge and mitigation clauses in a share sale agreement
It also considered whether the buyer had been under a positive contractual duty to take mitigating action after completion to reduce its loss.
Equitix EEEF Biomass 2 Ltd v Fox  EWHC 2531 (TCC) concerned the sale of the shares in a biomass company by various individuals and another company.
The terms of sale were set out in a share sale and purchase agreement (an SPA). As is usual, the SPA contained warranties given by the sellers concerning the state of the business.
The buyer brought claims against the sellers alleging that numerous warranties were untrue. The court found in each case that the relevant warranty was untrue. The key questions for the court were:
- Was the buyer aware of the breaches before it signed the SPA? If so, did the SPA prevent it from claiming?
- Did the SPA require the buyer to take action after completing the sale to reduce (or mitigate) its loss? If so, should any damages awarded to the buyer be reduced to reflect this?
The question of knowledge
The general assumption is that the law prevents a buyer from claiming for breach of warranty if the buyer knew about the matter giving rise to the breach before entering into the sale and purchase. This can be explained either as a way to prevent a buyer from taking unfair advantage of this kind of knowledge, or by the fact that the buyer must have factored the breach into the purchase price.
It is nonetheless common to include specific wording in an SPA to prevent a buyer from bringing a warranty claim if the buyer already knew of the breach. This usually takes one or both of two forms:
- A warranty or confirmation that the buyer is not aware of any warranty breaches. This is designed to set up a counterclaim by the sellers that effectively “nullifies” the warranty claim, or a so-called “estoppel” that prevents the buyer from bringing a claim in the first place.
- A limitation on the sellers’ liability stating that the buyer cannot bring a claim, and/or that the sellers are not liable for a claim, if the buyer was aware of any warranty breaches when the buyer signed the SPA. This is a simple exclusion of liability.
If the buyer is a company (as it was in this case), this often extends to the actual knowledge of other companies in the buyer’s group.
In this case, the SPA contained both provisions. The confirmation clause read as follows:
[The Buyer] confirms to the Sellers that … neither it nor any other member of the Buyer Group … is actually aware of any fact, matter, event or circumstance which constitutes a breach of Warranty as at the date of this Agreement …. For this purpose, the Buyer and the relevant members of the Buyer Group shall be deemed to have knowledge of anything of which any of [Mr] Cashin and [Dr] Archer are actually aware of [sic] at the date of this Agreement.
The limitation clause read as follows:
The Buyer shall not be entitled to bring a claim and the Sellers shall have no liability to the Buyer where the facts and circumstances giving rise to the claim are within the actual knowledge of the Buyer (which for this purpose means the actual knowledge of [Mr] Cashin and [Dr] Archer … .
Mr Cashin and Dr Archer were both directors of the buyer.
The sellers argued that these two provisions achieved different things. They agreed that the limitation clause applied only if Mr Cashin and Dr Archer were aware of the breach. This was the effect of the words “which for this purpose means”.
However, they argued that the confirmation clause was not limited to the two named directors. They said the words “deemed to have knowledge” was non-exhaustive and included not only anything Mr Cashin or Dr Archer actually knew but also anything the buyer actually knew through other means (for example, anything the buyer’s technical consultants had specifically informed them about).
This was a cogent argument. There is a presumption that, if two clauses are worded differently, the parties intended them to mean different things. Otherwise, they would have used the same language.
However, the court disagreed with the sellers’ interpretation. The judge noted that, because Mr Cashin and Dr Archer were directors of the buyer, anything they knew would automatically be attributed to the buyer. It was therefore unnecessary to repeat this in the SPA and the only reason to refer to them specifically was to limit the buyer’s actual knowledge to them.
The judge said this interpretation sat better with the limitation clause. He said there would have been an “anomalous asymmetry” if the confirmation clause had been broader than the limitation clause.
The question of mitigation
Under English law, a party to a contract cannot claim contractual damages that could have been avoided by taking reasonable steps. This is usually referred to as the “duty to mitigate”. However, strictly speaking, it is merely part of the method for calculating an award of damages, so we will use the alternative label: the “doctrine of mitigation”.
It is common to include additional specific drafting in an SPA placing an explicit contractual obligation on a buyer to “mitigate its loss” and reducing the sellers’ liability if the buyer fails to do so. The SPA in this case contained such a clause, which read as follows:
The Buyer shall (and shall procure that the [target company] shall) take all reasonable action to mitigate any loss suffered by it or the [target company] which would, could or might result in a claim … against the Sellers.
The doctrine of mitigation is rarely useful to the seller of a company or business in relation to a warranty claim. This is because the doctrine generally applies to actions a party could have taken before a breach occurs. However, a breach of warranty usually occurs when an SPA is signed, and the buyer will rarely be able, before that point, to do anything to avoid or minimise it.
In this case, the buyer claimed that the express duty to mitigate in the SPA merely “codified” the doctrine of mitigation. It therefore added nothing to the general position and had no effect on the buyer’s claims. Even if it did apply, the buyer argued, the sellers were required to bring a counterclaim for breach of the contractual duty to mitigate to make use of the clause.
The sellers argued that the express duty in the SPA had to go further than the doctrine of mitigation; it would be redundant otherwise. They said it required the buyer to take mitigating action not just before, but also after discovering the breach of warranty. They also said it required the buyer to take all reasonable action to mitigate its loss (imposing a higher bar than the doctrine of mitigation, which simply requires a buyer to take action which it would be unreasonable not to take).
The court came down in the middle. The judge agreed that the contractual clause created a positive duty on the buyer to mitigate its loss and said there was no need for the sellers to launch a counterclaim to invoke it.
However, the clause did not impose obligations that were more onerous than the doctrine of mitigation (although it could have done so, if the parties had used the right words). In particular, it did not require the buyer to take mitigating action after discovering the breach. That would have imposed far too high a standard and required the buyer effectively to remedy the sellers’ breaches using its own money.
What does this mean for me?
Both points of this case illustrate a key point. English law generally caters very well for the regulation of contractual relationships between parties. The courts have developed doctrines of awareness and mitigation over centuries to ensure fairness and justice.
Parties to a contract should think carefully before including provisions that simply mirror the position at law. It is difficult to replicate years of jurisprudence concisely in a paragraph or two and simply invites the courts to find some other, often unexpected, meaning for a contractual provision.
Both examples also show that contract parties are free to “modify” the position at law (although this is not possible in all cases). However, they must use clear wording if they intend to do this and ensure there is no ambiguity over what is intended.
And, above all, similar clauses within a contract should be consistent with each other. If they are to have differing effects, the parties should consider making this clear and spelling out how the provisions are intended to work.