Earn outs - the importance of delivering a correct earn-out notice and the benefit of aligning earn-out periods with the buyer’s accounting period

The Court of Appeal (in Treatt Plc v Barratt and others [2015] EWCA Civ 116) recently considered whether an earn-out notice was valid. The notice had been correctly delivered by the buyer and not contested by the seller within the time period set out in the underlying sale and purchase agreement (SPA). However the accounts on which the amount of earn-out was calculated were not the ones specified in the SPA. The seller contended that because the “wrong” accounts had been used the notice was invalid.

The SPA provided that the earn-out would be based on the target companies’ audited accounts ending 31 December. The buyer had aligned the companies’ financial years with its own and, as a consequence, had calculated the earn-out amount based on audited accounts ending 30 September, topped up with management account figures for October, November and December. The court found that the notice was invalid; the basis of calculation of the earn-out was not a “mere formality” but a “form of contractual protection to the Sellers of real importance”. The court noted that there was a difference between mathematical errors in calculating the sum due (which in part was what the procedure for expert determination was intended to resolve) which do not invalidate a notice and substantial departures from the contractual provisions, which do. There was no evidence that the buyer’s approach was intended to subvert the method for calculating the earn-out. The buyer appeared to have a “mistaken belief” that the process was in conformity with the SPA.

Impact – the case is a reminder of the potential benefit, when drafting earn-out provisions, of aligning an earn-out period with the buyer’s accounting period and of the need to deliver an earn-out notice which complies with the requirements of the SPA.

Acceptance that a report could not be relied upon by a non- addressee where it contained a reasonable disclaimer of responsibility to third parties

The High Court in Barclays Bank plc v Grant Thornton UK LLP [2015] EWHC 320 dismissed a claim by Barclays that Grant Thornton owed the bank a tortious duty of care.

Grant Thornton had been retained by a company to audit its non-statutory group financial statements. The company had provided those audit reports to the bank in conformity with  its obligation under its facility agreement with the bank. Grant Thornton was aware that the reports would be used in this way, even referring to the company’s obligation on the first page of the report. The judge noted that in the absence of any disclaimer it would be “clearly arguable” that a duty of care would exist between the bank and Grant Thornton, having regard to the relevant authorities.

The key point was therefore whether Grant Thornton’s disclaimer of liability, to anyone other than the report’s addressee, negated a potential duty of care to the bank and  was reasonable under the Unfair Contract Terms Act 1977 (UCTA) (the application of UCTA was assumed for the purposes of the proceedings). The disclaimer largely followed the ICAEW’s standard wording.

The court found that the disclaimer was reasonable. It was assisted in this conclusion by:

  • the fact that the auditor had previously been specifically engaged by the bank in relation to matters concerning the same company. Where the bank had intended to rely on the auditor’s work it had entered into a contractual relationship with it and as part of that engagement the auditor had, in accordance with its usual practice, limited its liability;
  • the audit reports were very short and the disclaimer appeared in the second paragraph on the first page. It was not buried in the small print at the back of a large document;
  • the reports were clearly addressed only to the company (the bank had not asked that the wording be amended to impose a direct duty on the auditor to the bank); and
  • the bank was aware that auditors did not like undertaking responsibility to persons other than their clients and often sought to avoid it and that Grant Thornton, in particular, sought to negate or restrict its liability in different ways both for statutory and non-statutory reports.

The court noted that if the disclaimer had not been reasonable it would be in the unenviable position of considering whether Grant Thornton’s limitation of liability would apply. If it did not apply it would “be wholly unjust if the non-contractual entity could rely on statements made primarily to a client with a contractual limitation and assert responsibility on behalf of the auditor to it without any such limitation”.

Impact – the decision highlights the benefit to a report’s author in including a clear disclaimer of responsibility to anyone other than the report’s addressee. Particularly where, as in this case, a tortious duty of care may otherwise be found to exist (the court noted that the absence of a disclaimer may help to establish the existence of a duty).

Background – Under UCTA a person cannot exclude or restrict his liability for negligence except insofar as the term or notice satisfies the requirement of reasonableness. The requirement of reasonableness is explained as meaning, in relation to a notice, that it should be fair and reasonable to allow reliance on it, having regard to all the circumstances obtaining when the liability arose or (but for the notice) would have arisen. It is for the party claiming that a notice satisfies the requirement of reasonableness to show that it does.


Schemes of arrangement – prohibition on the use of cancellation schemes on a takeover – 4 March 2015

The use of a cancellation or reduction of capital scheme of arrangement (scheme) by a target company the subject of a takeover is no longer permissible. Regulations amending section 641 of the Companies Act 2006 (circumstances in which a company may reduce its share capital) are now in force. The changes prohibit a company from reducing its share capital as part of a scheme in which a person (either alone or together with associates) will acquire all the shares, or all the shares of a particular class, in the company. Cancellation schemes will still be available for other purposes.

An initial draft of the regulations defined “scheme” to mean “a scheme of a kind described in section 900(1)(a) and (b) of the Act”. Subsequent draft regulations defined it more broadly to mean “a compromise or scheme of arrangement sanctioned by the court under Part 26”. No subsequent changes were made to the regulations prior to them coming into force.

Impact – The regulations came into force on 4 March 2015 and apply to all future cancellation schemes. Transitional rules provide that where an announcement concerning a firm intention to make an offer has been made (or agreed in the case of a company that is not subject to the Takeover Code) before that date the prohibition will not apply. There are a couple of points of interest on the drafting of the regulations which may allow cancellation schemes to continue to be used in certain circumstances however any such scheme would still need court approval (which is discretionary). Transfer schemes, where shares in the target not already owned by the bidder are transferred to the bidder (and therefore generally attract stamp duty), are still permitted.

Background – A scheme is a statutory procedure under the Companies Act 2006, enabling a company to make a compromise or arrangement with its members or creditors. In recent years takeovers have been increasingly structured as schemes rather than contractual offers. Schemes can have a number of benefits over contractual takeover offers. Prior to implementation of this regulation one benefit was, if structured as a cancellation or reduction scheme, the absence of an obligation to pay stamp duty because no shares in the target were transferred. Instead, all the shares in the target not already owned by the bidder were cancelled by a reduction of capital of the target and consideration paid to the target shareholders in consideration for the cancellation of their shares. The reserve created by the cancellation was capitalised and applied in paying up new shares issued by the target to the bidder.


  • The Small Business, Enterprise and Employment Bill (section 3) envisages that large companies may be required to publish details of their payment practices. BIS has published the responses it received to its consultation considering which entities may be within scope, the content of the report and timing of its production/ publication. BIS is currently analysing the responses with a view to publishing proposed regulations after the UK’s forthcoming general election. In conjunction with the Government’s drive to improve reporting of payment practices the Government also announced this week its intention that 30 day payment terms would become standard. 60 days will be the new maximum limit under the Government’s voluntary Prompt Payment Code. Independent analysis suggests that 60 per cent of the UK’s supply chain value has signed up to the code. Changes will be phased in over the coming months.
  • On 1 April 2015 the Financial Conduct Authority will acquire powers enabling it to enforce competition law alongside the UK’s primary competition law regulator, the Competition and Markets Authority (CMA). These powers will complement its existing duty to promote effective competition. Whilst the FCA and CMA will co-ordinate their work, the FCA is expected to undertake a greater number of competition investigations within the financial services sector.
  • The FRC has published a compendium of audit and assurance standards and guidance effective for financial periods commencing on or after 1 October 2014. Publication coincides with a report by the International Forum of Independent Audit Regulators (IFIAR) on public company audits. The IFIAR report found a high number of deficiencies with the companies’ reports it surveyed and called for initiatives to improve audit quality.