Potential pitfalls of “prospects” warranties

Potential pitfalls of “prospects” warranties

Anyone who has sold a business knows that the buyer usually seeks warranties from the seller in the sale and purchase agreement. Warranties are a set of promises about what has happened in the life of the business in the time leading up to its sale and generally are the subject of much negotiation between the contracting parties. Warranties usually cover events in the past – i.e. in the time up to the date of sale.

Spotlighting a recent case: Inc Holdings Proprietary Ltd v Garbett

Inc Holdings Proprietary Ltd v Garbett has demonstrated very clearly the need to be aware of the potential for warranties to cover future events as well as the history of the business. This case centred around a purchase by a buyer of a company in relation to which the sellers had repeatedly provided very optimistic financial forecasts for the period after the scheduled completion of the sale and purchase. The share purchase agreement contained a warranty (promise) that “Since […] there has been no material adverse change in the turnover, financial position or prospects of the Company”. While there has been a lot of talk about “material adverse change” warranties, we’re only considering the relevance of the warranty looking ahead to beyond completion of the sale and purchase through its inclusion of the word “prospects”, rather than solely to the historical position.

Some time after the sale completed, it became apparent that the company was not performing at the financial levels expected from the optimistic forecasts that had been provided before the sale – and the buyer alleged a breach of that warranty. Essentially, the sellers were alleged to have known when giving the warranty (i.e. at the time that the sale and purchase agreement was signed) that there had indeed already been a material adverse change in the prospects of the company, hence its poor performance after completion. The case was really about the difference between the buyer’s perception – created by the seller stating that there had been no change in the prospects of the company at the time that the agreement was signed – and the factual position that there had indeed been a material adverse change in the prospects of the company at that moment.

The case went to trial and the buyer succeeded. The sellers were liable to pay to the buyer £1.31m plus interest and costs. The court found that it was clear to the sellers when they promised the buyer that there was no material adverse change to the prospects of the company that in fact there had been such a change – and so the warranty was breached. The fact that the seller had provided forecasts and the fact that the buyer had focused on the company’s future gross profits meant that it was clear that the buyer was relying on the warranty that the prospects at the time of the agreement were as forecast by the sellers.

What does this mean for me?

Quite apart from how the words “material adverse change” are dealt with in sale and purchase agreements and by the courts (which is a really complex area in itself), this case demonstrates why it is important to understand each word used in every warranty and what it might mean both to a buyer and a seller. Had the word “prospects” not been used and had the warranty not clearly looked towards future performance, there may not have been a successful warranty claim in this case.

Contact us

At Rix & Kay Solicitors we have a dedicated and passionate Corporate and Commercial team with years of experience in negotiating warranties of all descriptions. If you are contemplating selling your business, reach out to Kathryn Paisley, Partner of the Corporate Commercial team, via e. KathrynPaisley@rixandkay.co.uk or via t. 01825 744447.