Private equity sellers and buyers carefully negotiate the time periods during which post-closing indemnification claims may be made in the acquisition agreement for a target company, assuming in the current market there is any post-closing indemnification at all. For the private equity seller, the survival period is intended to demark the time after which there should be no continuing exposure to whatever limited indemnification obligations were agreed to by the seller and following which the escrowed funds, if any, are released. But frequently, what actually happens is that the buyer determines that there is a “possible” claim that has not yet been asserted or has not yet occurred, and then seeks to give notice of that unripened claim in order to extend the survival period indefinitely until that claim actually ripens and is thereafter resolved. And in some cases a third party claim may have actually been made, but the mere existence of the claim does not constitute a breach of any representation and warranty in the purchase agreement. The buyer nonetheless seeks indemnification for defending that claim.1 In still other cases, the buyer may have sustained, is sustaining, or will sustain, a direct loss as the result of an alleged breach of a specific representation and warranty and seeks to give the required notice of those incurred and anticipated losses to the seller prior to the end of the survival period. The success of the buyer in asserting such claims, and thereby extending the survival period, depends not only on the exact language used in the indemnification provisions of the acquisition agreement, but also on the exact language used in (and the timeliness of) the written notice provided by the buyer to the seller asserting these claims.
A 2016 post to Weil’s Global Private Equity Insights blog, entitled Making Sure Your Survival Periods Work as Intended,2 reviewed the importance of the exact language used in the indemnification provisions in determining whether a buyer can legitimately assert “placeholder claims” (i.e., claims that certain facts have come to light or assertions by third parties have been made, that, if true, would constitute a breach of the specific representations and warranties in the acquisition agreement) to extend the applicable survival period, even though no loss has yet been incurred and no actual breach of any representation and warranty has occurred. The issues raised by that prior blog post remain issues as to which both the private equity seller and buyer must remain vigilant if they wish to obtain the benefit of their actual bargain. But recent cases in both the United States and England highlight still another issue that plagues the assertion of post-closing indemnification claims—the exact words used in the written notice asserting a claim and its compliance with the specific terms of the acquisition agreement.
Frequently, a written notice of claim provided prior to the end of the survival period is specifically required to state the claim in “reasonable detail,” include an estimate of the loss, and specify the specific representations and warranties of the seller that have allegedly been, or will be, breached as a result. And those requirements typically exist whether indemnification extends only to alleged “actual” breaches of the representations and warranties that have already occurred, covers threatened third party claims or only actual litigation, requires defense of claims that do not themselves constitute an actual breach of a representation or warranty, or otherwise permits claims respecting anticipated but not yet realized breaches or losses.
While the English approach to post-closing warranty claims is somewhat different than the indemnification approach in the U.S., the survival period construct, and the requirement to give a valid notice of claims in order to preserve such claims prior to the end of that survival period, appears to be very much a part of English deals, just like U.S. deals. And a recent decision of the English Court of Appeal, Teoco UK Limited v. Aircom Jersey 4 Limited,  EWCA Civ 23, illustrates the importance of following the exact requirements set out in the purchase agreement in order to make certain a notice of claims is valid.
The purchase agreement at issue in the Teoco decision required the buyer’s claims notice to set out “reasonable details of the Claim (including the grounds on which it is based and the Purchaser’s good faith estimate of the amount of the Claim …).” The notice provided by the buyer, however, appeared to be more of a “reservation of rights” regarding claims that “may exist” with respect to the warranties generally, and did not make reference to any specific warranties that had been breached. According to the court, sending a notice in order “to keep the Purchaser’s options open” was not the same as providing notice of an actual claim based on specifically identified warranties as was required under the purchase agreement. The buyer was, therefore, denied its right to pursue a warranty claim due to its failure to comply strictly with the claims notice requirements specified in the purchase agreement.
The suggestion that a notice needs to make an actual claim based on identified, specific warranties, rather than simply notifying the seller that there may be a basis for a claim in the future,3 echoes some earlier Delaware decisions that rejected so-called “placeholder claims” where the terms of the purchase agreement did not contemplate such claims.4 But the key take-away from Teoco is that an obligation to provide “reasonable detail” of a claim requires doing just that. And a recent Delaware Court of Chancery decision, The HC Companies, Inc. v. Myers Industries, Inc. C.A. No. 12671-VCS (Del. Ch. Dec. 5, 2017), reinforces that message.
In HC Companies, the buyer provided a purported indemnification claims notice to the sellers, two months following closing, claiming $8 million in losses and asserting that the equipment purchased pursuant to the purchase agreement was not in “good condition.” The seller had warranted in the purchase agreement that the purchased equipment “is in good condition and in [a] state of good maintenance and repair in all material respects.” The purchase agreement specified, however, that any indemnification claim notice respecting a direct claim, “shall describe the Direct Claim in reasonable detail, shall include copies of all material written evidence thereof and shall indicate the estimated amount, if reasonably practicable, of the Loss that has been or may be sustained by [the buyer].” The sellers objected to the buyer’s purported indemnification claims notice, within the time limits for objection, on the ground that the claims notice lacked sufficient detail.
Had that been where this ended, the buyer in HC Companies may have ended up in the same position as the buyer in Teoco; i.e., having forfeited its right to pursue its breach of warranty claim for failure to follow the notice procedures set forth in the purchase agreement. But the buyer here was able to send a timely second notice, to which the sellers failed to object within the specified time period. The second notice identified specific equipment that the buyer alleged was not in good condition, together with detailed charts and experts’ opinions as to damages. The sellers’ failure to make a timely objection to that second notice resulted in the sellers being deemed to have accepted the buyer’s claim pursuant to the specific terms of the indemnification procedures in that particular purchase agreement and related escrow agreement.
The indemnification procedures set forth in private company acquisition agreements can be complicated and require an experienced eye. And while many deal professionals may be tempted to assume that indemnification procedures are all alike, the fact is that they can vary substantially. Both Teoco and HC Companies, despite their different outcomes for the seller and buyer, underscore the need for deal professionals and their counsel not only to craft the terms of their written acquisition agreements respecting their desired indemnification procedures carefully, but also, having done so, to read and abide by those terms in making indemnification claims and asserting objections to those claims. Your survival period (or at least its continuation) may depend on it.