In a decision that may have implications for the disclosure process, the Court of Appeal has held that a warranty should be interpreted on a commercially sensible basis, and that the interpretation could override the natural language of the warranty in order to give effect to the commercial intention of the parties (Belfairs Management Limited v Sutherland & Anor (2013)).

The court also confirmed that an objective assessment was required when determining whether a warranty had actually been breached.

The dispute

In the share purchase agreement ("SPA"), the claimant agreed to buy a majority stake in Waveform Solutions Limited (the target) from the respondents for £2 million. As part of the transaction, the claimant agreed to provide an additional £600,000 to the target by way of an interest-free loan, and the respondents agreed to lend the target £1 million from the sale proceeds.

The SPA contained a warranty which stated that: "The Company [target] is not a party to any agreement, arrangement or commitment which cannot be readily fulfilled or performed by it on time" (the warranty).

The target had previously been selected to enter into a framework agreement with the NHS (the framework agreement) but, as it needed a capital injection to do so, it delayed entering into the framework agreement until after the SPA had completed.

Six months after the SPA was completed, the target became unable to meet its obligations under the framework agreement and later entered into administration.

The claimant brought a claim against the respondents for, among other things, breach of the warranty. The respondents argued that the warranty had not been breached because the target had not entered into the framework agreement at the time that the SPA was signed, and therefore it could not be considered to be an "agreement, arrangement or commitment" of the target.

The High Court upheld this view. It also held, somewhat controversially, that the nature of a warranty could require a subjective assessment in circumstances where the warranty is not expressly qualified by, or otherwise refers to, the warrantor's view or opinion.

The decision

The Court of Appeal held that the framework agreement should be viewed as an agreement to which the warranty applied. The construction of the warranty turned on whether a reasonable person with all the background knowledge reasonably available to the parties at the time that the SPA was signed would regard the framework agreement as an "agreement, arrangement or commitment".

In so holding, the Court demonstrated a willingness to go beyond the natural language of the warranty in order to determine the commercial intention of the parties, and to interpret the warranty in the context of the overall commercial agreement between the claimant and the respondents.

It was noted that the respondents had proposed that the claimant make its loan to the target, which had then allowed the target to enter into the framework agreement, so the conclusion of the framework agreement between the target and the NHS must have been contemplated by both parties at the time the SPA was signed. The court therefore decided that, on a commercially sensible construction, the warranty must have been intended to apply to the framework agreement.

The court also held that in order to determine whether the warranty had been breached, it was necessary to conduct an objective assessment as to whether the framework agreement could be fulfilled or performed by the target at the time the SPA was signed.

Comment

It is interesting that the court decided to reject a literal reading of the warranty as courts have previously been reluctant to attempt to determine the commercial intention of contractual parties, particularly if such an approach would be contrary to a literal reading of a contract.

The willingness of the courts to consider the parties' commercial intentions when entering into a contract has important implications for the disclosure process. Legal advisers will need to ensure that sellers are fully aware of the implications of Belfairs when advising on disclosure exercises, and should encourage sellers to take a broad and expansive approach to disclosure. Equally, warranties should be carefully drafted in order to refer expressly to any specific issues or commitments which are particularly important to the buyer or to the commercial transaction as a whole. There is a danger that a lack of clarity within a contract could result in the courts incorrectly implying knowledge or intention to the parties.

It is arguable, however, that the court's decision can be limited to the facts of the case. For example, it was clear that both parties intended the target, once recapitalised, to enter into the framework agreement. The framework agreement was therefore at the heart of the commercial agreement between the claimant and the respondents, and considered to be of the utmost importance to the target.

In addition, the disclosure letter from the respondents disclosed certain information regarding the framework agreement, indicating that the respondents themselves considered the framework agreement to be an "agreement, arrangement or commitment" of the target within the context of the SPA. However, the court did not expressly consider whether the contents of the disclosure letter could be invoked as part of the construction exercise.

The court's decision that a warranty required an objective assessment when determining if it had been breached may also be explained by the facts of the case. The wording of the warranty did not refer to the knowledge or belief of the respondents, and the court found no other reason to suggest that a subjective test should be applied.

This case highlights the importance of reflecting the commercial intention of the parties when drafting agreements. Legal advisers need to understand the commercial drivers behind transactions and, when advising a seller, should ensure that the disclosure exercise is thorough and, if necessary, having regard to the commercial circumstances, extends beyond the literal scope of the agreed warranties.

This article first appeared in PLC.