The recent High Court decision of Clark v Macourt (2013) 304 ALR 220 reaffirmed the principle governing the assessment of damages for breach of contractual warranty, even if the application of the principle leads to surprising outcomes. In this case, the value of the damages exceeded the sale price of the business and the recoupment of the losses by the purchaser through separate commercial transactions did not reduce the value of the damages awarded. 

Seller warranties

Whether the sale is a sale of business and assets or a sale of shares, prudent well-advised purchasers would require sellers to provide comprehensive warranties in sale agreements, to ensure that the price paid reflects what the seller has disclosed to the purchaser about the assets and the business, and thereby allocating risk to the seller in respect of matters the subject of the seller warranties.

In the event that the warranty or the information disclosed by the seller is not true, the purchaser may seek damages against the seller. Consequently, the seller is required to compensate the purchaser in damages for losses suffered if the business or shares in the company transferred to the purchaser on completion does not meet the description contained in the warranties.

The surprising outcomes from the recent decision of Clark v Macourt is a reminder that parties must take care in drafting contractual warranties in sale agreements.

Clark v Macourt (2013) 304 ALR 220

Facts

In this case, the seller and the purchaser entered into a sale and purchase agreement to purchase a fertility practice for a purchase price of approximately $400,000. The stock sold comprised of 3513 frozen donor sperm samples.

The seller warranted that the donor sperm samples and the relevant identification documents complied with the required guidelines to allow them to be used in practice. However, it was undisputed that, in breach of the contract, over half of the samples did not comply with the guidelines and were therefore unusable.

The purchaser later purchased the replacement samples from Xytex, a supplier in the United States, for an amount of $1.2 million (which included collection, storage and transport expenses).  The purchaser subsequently recouped the losses by passing the costs to clients through patient fees.

The question before the High Court was the amount of damages which the purchaser should be awarded for breach of warranty in relation to the unusable donor sperm samples.

The two important outcomes of this case are:

  1. the determination of the value of the loss; and
  2. the effect of mitigation of the loss.

Determining the value of the loss

The High Court reaffirmed the “ruling principle” of assessment of damages set out in Robinson v Harman (1848) 1 Ex 850 – that in cases of breaches of contract, damages should put the plaintiff in the same situation, so far as money can do, as it would have been in had the broken promise been performed.

The High Court held that the value of damage is assessed as at the date of breach.  The loss was measured not by what the purchaser had originally outlaid to obtain the unusable stock but the value of what the seller had promised to deliver but did not. In this case, value was evidenced by what the purchaser had been required to pay for the replacement stock.

The application of the ruling principle led to the surprising result that the value of the damages (approximately $1.2 million) exceeded the consideration for the whole of the business and assets under the contract (approximately $400,000).

Mitigation of loss from breach of seller warranty

Although the purchaser had mitigated her loss by the subsequent recovery of the cost of the replacement stock from the patients, the High Court held that the acquisition of the replacement stock neither mitigated (nor aggravated) the loss suffered by the purchaser from the seller not supplying in accordance with the contract.

The High Court held that the evidence of what the purchaser had charged, or could charge, the patients was irrelevant to deciding the value of what the seller should have, but had not, supplied.

Consequently, the purchaser’s loss was measured by reference to what the purchaser had outlaid to put herself in the position she would have been had the contract been performed. Whatever transactions she then chose to make with her patients were irrelevant to determining the value of what should have been, but was not, provided under the contract.

Managing the risk of warranty claims

There are ways in which the risk of warranty claims may be managed.

It is important that parties to sale transactions consider the implications of each seller warranty. In particular, having regard to Clark v Macourt whereby damages awarded exceeded the purchase price, the seller should consider imposing a cap on liability for the different types of warranties.

Of course, the ability of the seller to contractually limit or exclude liability is subject to the overriding liability for misleading and deceptive conduct under provisions such as section 18 of Schedule 2 of the Competition and Consumer Act 2010.

Parties can also take out warranty and indemnity insurance policies to manage the risk of warranty claims by the purchaser.

Conclusion

Sellers, purchasers and their advisers should carefully review and consider the implications of each of the seller warranties and be cognisant that different methods may be utilised to manage the risks of seller warranties. Failure to consider and manage the risks of seller warranties can lead to dire consequences, as in the case of Clark v Macourt where the damages awarded against a seller exceeded the purchase price three-fold.