When shares in a company are sold under an SPA, the contract law principle of “buyer beware” means the buyer alone is responsible for making sure it understands what it is buying. That explains the due diligence that is usually conducted by buyers, where the buyer and its advisors scrutinise the target company and its assets and liabilities in rigorous detail.
Even if a buyer carries out a comprehensive due diligence investigation, issues often only materialise after closing, when the buyer owns the target company and has got involved in managing its business. So the buyer will usually also ask the seller to make binding promises – in the form of contractual warranties – about the state of the target company and its affairs. If those warranties turn out to have been inaccurate when made by the seller, the buyer may be entitled to bring a claim for damages for breach of contract.
If the buyer’s due diligence identifies a specific issue, but the impact of that issue is not sufficiently clear at the signing date, the buyer might ask to be compensated by the seller – in the form of an indemnity – if the issue materialises and has a financial impact on the target company.
Sellers will often negotiate a number of limitations to the buyer’s right to bring breach of warranty or indemnity claims. One such limitation is referred to as a “survival period”. The purpose of a survival period is to ensure that a seller will only be liable for warranty or indemnity claims for a specific period of time after the deal closes.
Facts of the Towergate case
The case of Towergate Financial (Group) Ltd & Ors v Hopkinson & Ors  EWHC 984 (Comm) related to the sale of a financial services business (Target), which was sold to an entity in the Towergate Financial Group (Buyer) under a share purchase agreement that was entered into in August 2008 (SPA).
For a number of years before the Target was sold to the Buyer, it had advised clients on transferring their assets out of defined benefit pension schemes into unregulated collective investment schemes. After the Buyer bought the Target, the UK Financial Conduct Authority (FCA) reviewed the advice that the Target had given under its previous ownership. The FCA review resulted in the Target being required to pay significant amounts of compensation to its clients.
The sellers agreed in the SPA that they would indemnify the Buyer for losses arising from any such review, but the SPA also provided that the sellers would only be liable under the indemnity if the Buyer notified them in writing as soon as possible and in any event on or before the seventh anniversary of the date of the SPA.
The Buyer first notified its insurers of possible claims under its insurance policy arising from the FCA review in February 2014. However, it did not notify the sellers of the potential indemnity claim until 29 July 2015, just before the seventh anniversary of the date of the SPA.
The Buyer contended that it had brought the claim within the contractual survival period. The sellers argued that the Buyer had not done so, because the notice was not given “as soon as possible”, so the Buyer had no right to be indemnified under the SPA.
The court held that bringing the claim within the contractual time limit was a condition precedent to the Buyer’s right to seek indemnification from the sellers. But, on its proper construction, it is a dual condition precedent that required the Buyer to notify the sellers (a) as soon as possible after it knew any matter or thing, which it knew or any reasonable person would know might give rise to a claim under the indemnity, and (b) in any event within seven years after the date of the SPA.
On the facts of the case, the court agreed with the sellers that the first part of this condition precedent had not been complied with, so the Buyer’s claim for indemnification failed.
Impact in the Crown Dependencies
The decision in Towergate could potentially be relevant to deals involving target companies in the Crown Dependencies that are governed by English law. It is also relevant to any person in the Crown Dependencies that has recently bought a company under an English law-governed agreement.
The decision will also be persuasive authority for deals involving target companies in the Crown Dependencies that are governed by the laws of the Isle of Man, Jersey or Guernsey, although it is not binding on the courts in those jurisdictions.
The full extent of the impact of this decision will depend on the precise drafting, but survival periods are commonly drafted using a form of words similar to that in the Towergate case. In some share purchase agreements, although the survival period will not include the “as soon as possible” limb, there will be a separate requirement to notify claims as soon as possible and in any event within a certain period that, although not a condition precedent to a claim, will reduce the damages payable to the buyer if the buyer’s failure to notify within the relevant period increases the target company’s loss (or prevents it from being reduced).
For deals that have already closed but where the survival period has not yet expired, buyers should pay close attention to the drafting of the survival period and, where necessary, should notify the seller as soon as possible after becoming aware of anything that might result in a claim. For pending deals, buyers should carefully consider the drafting of the notification of claims provisions and ensure that they understand exactly what they need to do if they become aware of grounds for a possible claim.
The implications of the decision could go beyond warranty survival periods in an M&A context because similar wording often appears in other provisions in corporate and commercial contracts (and also in statutory provisions).
By way of example, in a debt finance context, borrowers commonly undertake to deliver financial statements to the lender as soon as possible and in any event within a specified period after the end of the financial period to which they relate. Failure to do so would constitute an event of default, which could trigger cross-defaults under other obligations.
Similarly, data protection laws that apply in each of the Crown Dependencies, require data controllers to respond to data subject access requests without undue delay and in any event within a period of approximately one month – the exact requirement differs slightly between the three jurisdictions – after receipt of the request.
The extent to which the decision in Towergate will have broader ramifications remains unclear, since the judgment leaves open the possibility of different interpretations depending on the context.
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