Beware of the risks when notifying warranty claims

In Teoco UK Limited v Aircom Jersey 4 Limited, Aircom Global Operations Limited(1) the Court of Appeal upheld the High Court's decision to strike out certain breach of warranty claims on the basis that the buyer had given the seller inadequate notice of those claims. The buyer's attempt to keep its options open by drafting its notices widely proved fatal to its claims, as it failed to identify the specific warranties to which its claims related as required by the share purchase agreement.

Background

The respondent companies, Aircom 4 Jersey Limited and Aircom Global Operations Limited (the sellers), entered into a share purchase agreement to sell two companies to the appellant Teoco UK Limited (the buyer) for around £41 million.

Share purchase agreement

Under the share purchase agreement, the sellers gave warranties (Schedule 3), including certain tax warranties. The share purchase agreement also contained a tax covenant at Schedule 8. Schedule 4 set out limitations on the sellers' liabilities and, as such, was of central importance to the appeal.

Schedule 4, Paragraph 4 provided that the seller would not be liable for any claim unless the buyer had given notice to the seller of its claim "setting out reasonable details of the Claim", including the grounds on which it was based.

Separately, Schedule 4, Paragraph 13 provided that the buyer was obliged to give the seller notice containing "reasonable details" of any matter indicating that the buyer had or was likely to have a claim.

Also relevant was Schedule 4, Paragraph 10, which provided that in respect of a tax claim (as defined in the share purchase agreement), the buyer could make a claim under either the tax warranties or the tax covenant, but not both.

Notification letters

Following the acquisition, on February 19 2015 the buyer's solicitors wrote to the sellers regarding two potential tax claims relating to the tax affairs of the acquired companies in Brazil and the Philippines. The letter estimated the potential claim values to be £3.6 million and £200,000 respectively. The February letter did not identify specific warranties on which the potential claims were based, but instead referred generally to "Warranty Claims or Tax Claims". The February letter concluded with a general reservation of rights.

In a further letter to the sellers, dated June 29 2015, the buyer's solicitors purported to give a "further notification" in accordance with Schedule 4 of the share purchase agreement. This letter referred generally to claims under the tax warranties and the tax covenant and set out a breakdown of the tax due.

On August 14 2015 the buyer commenced proceedings in relation to the tax claims and on December 18 2015 the sellers applied to strike them out.

High Court decision

In summary, the judge granted the sellers' application to strike out the tax claims on the basis that the February and June letters had failed to comply with the specific requirements of Schedule 4 of the share purchase agreement (for further details please see "Caveat emptor: buyer's inadequate notice precludes £3.5 million warranty claim").

The judge at first instance found that:

Due to the contingent language and lack of specificity contained in the February and June letters, a reasonable recipient of those letters would not have understood them to be giving notice of the tax claims under Schedule 4, Paragraph 4 rather than notifying their existence (or potential existence) under Paragraph 13.
The February and June letters did not satisfy the requirements of Schedule 4, Paragraph 4 because they did not set out reasonable details of the claims, including the grounds on which those claims were based. Identifying the grounds of a claim required the identification of the specific warranties which were said to have been breached (or the basis of the trigger of the tax indemnity). The "omnibus" references to "Warranty Claims or Tax Claims" in the February letter and claims under the tax warranties and the tax covenant in the June letter were inadequate, with the latter falling foul of the requirement in Paragraph 10 make a claim either under the tax warranties or the tax indemnity.
The buyer appealed, arguing that there was no general principle that particular warranties must be identified where a notification clause in a share purchase agreement provides for details to be given of a claim. Further, the buyer argued that Schedule 4, Paragraph 4 did not in terms impose an obligation to specify individual warranties.

Court of Appeal decision

The Court of Appeal unanimously dismissed the buyer's appeal. In reaching its decision, the court held that the following principles applied to the construction of claim notification clauses:

"Every notice clause turns on its own individual wording" (RWE Nuken Ltd v AEA Technology plc).(2) However, reference to previous decisions can still be of some assistance.
Commercial certainty is of central importance. A seller must be able to plan for the consequences flowing from a notification of claim. This can be achieved only when a seller is left in no reasonable doubt not only that a claim may be brought, but also of the particular grounds on which the claim is to be based (Senate Electrical Wholesalers Ltd v Alcatel Submarine Networks Ltd).(3) In this case, there was real scope for doubt as to which provisions formed the basis for the claims.
It was conceivable that, exceptionally, the requirement to set out the grounds of a claim might be achieved without mentioning a warranty (eg, where recitation of the relevant facts unequivocally indicated a specific warranty). It was also possible to imagine circumstances in which a reference to the wrong warranty would not invalidate a notice. However, the general rule was that the requirement to set out the grounds of a claim required explicit reference to particular warranties. This was not a case where the buyer erroneously referred to the wrong warranty or the facts unequivocally pointed to a specific warranty.
The court referred to the decision in Nobahar-Cookson v The Hut Group Ltd,(4) in which the Court of Appeal approached the construction of a provision in a share purchase agreement comparable to the one in this case. In Nobahar-Cookson the court found that where the "tools of linguistic, contextual, purposive and common-sense analysis" were insufficient to resolve any ambiguity in the drafting of a notice clause with sufficient clarity, the contra proferentem principle provided that the provision should be interpreted narrowly and in favour of the buyer. In the instant case, the judge found there to be no ambiguity; it was incumbent on the buyer to specify material warranties or other provisions.

Comment

This decision demonstrates that a buyer's right to pursue a warranty or indemnity claim under a share purchase agreement can be jeopardised by failing to adhere to the requirements of a claims notification clause. In this case, the buyer took the wrong approach to keeping its options open. Instead of widely drafting its notices of claim and avoiding reference to specific warranties in favour of a general reservation of rights, the buyer would have been better served by specifying each of the warranties that were relevant in the circumstances.

While the decision might seem harsh – particularly in light of the High Court and Court of Appeal decisions in Nobahar-Cookson, where a similar notice provision was construed in favour of the buyer – it underlines the importance of paying close attention to notice provisions and conforming to their requirements.

^{Endnotes
(1) [2018] EWCA Civ 23.
(2) [2005] EWHC 78 (Comm).
(3) [1999] 2 Lloyd's Rep 423.
(4) [2016] EWCA Civ 128.}