The accepted measure of compensatory damages in this scenario is the difference between the warranted value of the company as at the date of the share purchase agreement (‘SPA’) and its real value.
To determine the ‘real value’ the court considers what price for the company a ‘hypothetical, reasonable and willing buyer’ and seller would have negotiated in an ordinary arm’s length transaction, had the buyer known of the seller’s breach of warranty before agreeing the buy the company.
The recent decision in Millbrook Healthcare Bidco Ltd v Mr Paul Croll and others serves as a reminder of the court’s approach when assessing damages in practice.
The Sale
Millbrook supplied healthcare equipment to various Clinical Commissioning Groups of the NHS. The sale price negotiated following consideration of Millbrook’s management accounts and financial pack, was reached by multiplying £6,600,000 (Millbrook’s rounded down 2019 EBITDA figure) by 6.8, and applying further pre-agreed adjustments.
Breaches of Warranty
The claims arose from the actions of a rogue commercial director, not called by either side as a witness at trial, who prior to the company sale (seemingly without the knowledge of his co-directors): -
negotiated a variation to one ongoing contract which rendered the contract loss making in the future; and
agreed to issue a credit note under a separate contract for an historic invoice for £285,519.14 plus VAT
The buyers’ case was that these acts rendered the sellers in breach of their ‘accounts fair and true’ and other warranties within the SPA regarding the accounts, which failed to reflect the true position.
The Arguments at Trial
Both parties relied upon evidence from expert valuers to assist the court quantify the impact of the breach of warranties upon the 2019 EBITDA figure. The sellers unsuccessfully attempted to attack the basis of the warranted value of the company on several grounds.
The buyers did not allege that the credited invoice, due to its historic nature, in fact impacted the 2019 EBITDA calculation, or that a reasonable and willing buyer would have taken this into account when negotiating the company purchase price, so this was not pleaded as causing any loss.
However, it was established that the varied contract contributed £302,100 towards the 2019 EBITDA figure, meaning it was overstated by this amount.
The buyers only discovered the true position regarding the varied contract many months after the acquisition when they become involved in a dispute with the NHS over sums they wrongly assumed were due to them. In time, this dispute became the subject of a settlement meeting at which the NHS agreed to pay the buyers £354,000 (£287,000 after tax) in settlement and allow them to retain a separate ‘overpayment’ under the contract in the sum of £118,129.
The sellers counterclaimed against the buyers by asserting that their claim would not have arisen had it not been for choices they made after the SPA i.e. entering into the above settlement and writing off the historic invoice. The judge rejected both these claims and held the buyers ‘did as well as they reasonably could’ describing the settlement as a successful mitigation of loss.
The sellers further contended that the £287,000 settlement sum should be factored into the court’s hypothetical assessment of the ‘real value’ of the company to significantly reduce the buyers’ losses. However, the court declined to do so because this argument only made sense in hindsight.
The Losses
The court accepted the EBITDA x a multiple approach to valuation and held that the difference between the warranted value and the real value in round figures was £2,000,000 (6.8 x £302,100). Further modest sums were deducted from this figure in respect of the pre-agreed financial adjustments, along with the £287,000 settlement sum, reducing damages to be paid by the sellers to £1,709,000.
Take Away
It is not always possible for the parties to plan for every eventuality when selling or buying a business and damages for breach of warranties in an SPA can be substantial.
During SPA negotiations, sellers’ solicitors can limit exposure to potential breach of warranty claims by negotiating caps on the sums recoverable, strict claim notification procedures and short limitation periods, which can act to bar some claims.
For buyers who become concerned following an acquisition, it is crucial to seek legal advice urgently to ensure full compliance with the SPA terms in respect of any potential claims.
Should you require any advice in connection with a recent business sale or acquisition, please contact our commercial litigation team by emailing anna.barnes@salehs.co.uk or carly.borne@salehs.co.uk or telephoning 0161 434 9991.
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