In March, the High Court handed down its judgment in Triumph Controls UK Limited & others v Primus International Holding Company & others  EWHC 565 (TCC), a claim for breach of warranty under an SPA.
The case covers many of the usual arguments in SPA disputes where large sums are at stake (in this case c.US$63.5m) and where the company purchased does not perform in accordance with expectations. In certain respects it also demonstrates how the approach towards such disputes might be different were the claim brought under W&I insurance. We comment on this below.
Amongst other things, the Court considered (i) what is required under SPA notification clauses, (ii) a warranty that there was “careful” preparation of forecasts (which illustrates the importance of the language used for certain warranties), and (iii) the legal test for determining damages (the parties accepted that the Court needed to ascertain the difference between the ‘true’ and ‘as warranted’ value of the company, but disagreed on how the ‘true’ value should be calculated). In this article we consider the Court’s decision and the potential implications for claims assessment in the growing W&I insurance market.
The claimant (“Triumph”) is a multinational aerospace and defence manufacturer / service provider. The defendant (“Primus”) is a multinational manufacturer of complex aircraft components. By a share purchase agreement dated 27 March 2013 (the “SPA”), Triumph purchased the share capital of three subsidiary Primus subsidiaries specialising in the manufacture of composite components for the aerospace industry. The value of the subsidiaries lay in their potential for future profitability, which was partly dependent upon the successful transfer of manufacturing operations to a factory site in Thailand.
Following purchase of the subsidiaries, Triumph brought a claim against Primus for damages of c.USD63.5m in respect of various alleged breaches of warranty. There had been a significant shortfall in expected revenue. Primus denied all the alleged breaches arguing that the claim was essentially due to “buyers’ remorse” in circumstances where Triumph had knowingly purchased loss-making companies. Primus further argued that Triumph’s claims failed because the notice of its claims failed to comply with the notice clause requirements under the SPA.
The judge found that Primus’ financial profit projections had not been carefully prepared in certain important respects. In particular, the profit projections did not reflect that the transfer of manufacturing to Thailand faced delays for reasons which were already known when those projections were prepared.
The form of Notification
As is fairly typical, the SPA required Triumph to notify its claims within 18 months of completion, “summarising the nature of the Claim so far as it was known” and “the amount claimed”. Equally typical for SPA disputes, Primus sought to deny the entire claim on the basis that notification was inadequate. Primus relied primarily on the fact that Triumph’s pleaded case diverged from, and expanded upon, the claims previously notified.
Save in one respect, the Court found Triumph’s notification to be adequate. The Court found that the requirement to summarise the nature of the claims did not require full details or particulars of the claims, as in a pleading. The SPA simply required the buyer to give formal, unambiguous notice of the basis of the allegations, sufficient for Primus to investigate, respond to, and make financial provision for the claims. The Court excluded one, important, head of claim on the understandable basis that the notification letter did not refer to it at all.
We find the Court’s decision unsurprising. It is normal when defending high value litigation to take all points available, but we consider the notification arguments illustrate an important difference between SPA disputes and the adjustment of a claim under W&I insurance. Save in respect of the disallowed head of claim, this was a technical defence taken in view of past cases which have strictly enforced the language of SPA notification clauses. In our experience, W&I insurers determine cover without the same strict regard to such arguments; the task of determining whether a loss is covered under a W&I Policy is not the same as identifying defences employed in High Court litigation. We suggest this is an important point of difference which illustrates the value of W&I Policies to the M&A market.
The warranty relating to Primus’ forward looking projections
Primus warranted that forward looking projections relating to the targets had been “honestly and carefully prepared”. Triumph failed to establish any other breach of warranty. Therefore, use of the seemingly innocuous term “carefully” in this warranty was highly significant in the dispute.
The Court found that determining whether the projections had been “carefully” prepared required an objective test. “Careful” preparation is not a recognised accounting term, and whether the standard has been met is a matter of judgement based on professional experience.
Triumph focused on the proposed transfer of production to a site in Thailand. Triumph alleged that the projections had not properly accounted for the obvious challenges of relocation (e.g. training, creating buffer stock, delays, and realistic cost). Primus countered that it had given no warranty as to the accuracy of the projections, and that it has based the projections on due and careful enquiries.
The judge found for Triumph, holding that a number of the assumptions that had informed the projections were unrealistic. Primus had not, for example, taken into account recent operational difficulties which the subsidiaries had encountered.
This decision is a reminder of the dangers of warranting future performance, in particular where, as here, the warranty turns on language that is open to an argument that there has not been compliance with the requirements. The warranty could for example, have required “careful enquiry” with specified members of management, which would have made compliance with the warranty more easily verifiable. Or it could have warranted the quality of the projections by reference to particular accounting standards. Projections go to the heart of the commercial rationale for a deal, and if a buyer negotiates contractual protection by means of a warranty, we consider it is reasonable for a W&I insurer to treat them differently (for example, excluding them entirely from cover).
The Court’s approach to establishing the “True Value” of the Company
The measure of damages in an SPA warranty claim is usually the difference between the value of the shares as warranted, and their ‘true’ value on the warranty date (for more discussion on this aspect, click here). This case shows that establishing the amount of this difference can be highly contentious when determining the ‘true’ value of the shares.
The expert witness for each side took a markedly different view of how the Court should arrive at the ‘true’ value of the purchased subsidiaries. Primus argued for a valuation based on the asset value of the business (i.e. current market value of assets of the business, less its outstanding liabilities). Triumph favoured a discounted cash flow approach, which anticipated future economic benefits / cash flows from the assets, applying a discount rate to arrive at current value.
The Court preferred Triumph’s approach. Triumph had purchased going concerns, and would remain active businesses. The subsidiaries’ value was intended to lie in production revenue, rather than underlying asset value. A court will seek to put a purchaser in the position it would have occupied had the contract been properly performed, i.e. where there were no breaches of warranty – and that means looking at, and usually following, the same method of valuation as the purchaser employed.
Given the sums in dispute, disagreement over the methodology for arriving at “true value” is unsurprising. However, as the number of claims under W&I insurance increase, it will be interesting to see whether the same disagreements emerge when insurers determine the extent of the covered loss under a W&I policy. We predict a more consensual approach to determining “true value” by insureds and insurers alike.
Finally, a brief reference to the significance of Disclosure Letters in the context of a breach of warranty claim. An SPA will typically contain a provision that the seller does not breach a warranty where the seller has already set out in the Disclosure Letter the matters which have given rise to the claim. The wording of that provision is therefore important. Here, the Court found that the relevant clause imposed an obligation to disclose the nature of the matter which would otherwise found a breach of warranty, and the provision allowed for this disclosure to be “in or under” the Disclosure Letter. Triumph argued that none of the documents referred to in the Disclosure Letter fairly and clearly disclosed the true and full extent of the operational situation at the subsidiaries. That was not, however, the applicable test under the relevant warranty, which the Court pointed out required the “nature” of the matter, the subject of the claim for breach of warranty, to be disclosed. The warranties found by the Court to have been breached by Primus did not cover the extent of operational failings. Their scope was limited to claims, threatened claims and circumstances that might give rise to claims. The nature of the operational failings and the claims articulated by customers, were found to have been fairly and clearly disclosed.