There have been a number of recent English Court judgments of interest in the corporate field and this corporate update reports on cases relevant in relation to warranties and representations in M&A transactions, restrictive covenants in acquisition agreements, the enforcement of foreign judgments in cross-border insolvency proceedings and the piercing of the corporate veil.
WARRANTIES OR REPRESENTATIONS? - Ensuring clarity of intention when drafting acquisition agreements
Problems often arise post-acquisition when the buyer discovers that the financial affairs of the target mean that the buyer either paid too much for the target or should not have undertaken the acquisition at all.
In Sycamore Bidco Ltd v. Breslin and Anor an acquisition vehicle (SBL) formed by a private equity firm (D) acquired the shares in a company (GAS) which provided consultancy and brokerage services in relation to insurance products. A minority stake in GAS was also taken by a management buy-out team from GAS who subsequently became directors of the buyer.
Post-acquisition, D uncovered some irregularities in the audited accounts which it had relied on in negotiating the price for GAS which meant that GAS was not worth what had been paid for it.
The share purchase agreement (SPA) contained what could be considered quite usual warranties relating to the accounts, including that they:
- showed a true and fair view of the state of affairs, assets and liabilities and profits or losses of the target; and
- were prepared in accordance with generally accepted accounting principles.
The operative warranty clause stated “the vendor warrants to the purchaser that, save as fairly disclosed by the disclosure letter, the warranties are true and accurate in all material respects”.
The important point in this case was that, in addition to suing the sellers for breach of warranty, SBL also claimed that each of the warranties that had been breached was also a false misrepresentation which had induced it to buy GAS. In English law a breach of warranty gives rise to damages, assessed so as to put the claimant in the position it would have occupied had the warranty been performed. However, a successful claim for misrepresentation means that the contract may be voidable and the parties placed in their pre-contractual position, or damages awarded to achieve that result. In this case, the warranty claim was likely to result in damages of around £6 million, but the claim for misrepresentation could have reached or exceeded the purchase price of £16.75 million paid by SBL for GAS.
Explicitly over-ruling previous High Court authority, the judge found that the express warranties in the SPA were only warranties and did not amount to representations for the following reasons (among others):
- the clear distinction between warranties and representations would have been understood by the draftsman of the SPA;
- in this case, the warranties were described as such and nowhere referred to as representations, and there was no case for extending the words beyond their natural meaning;
- the disclosure letter referred to in the SPA distinguished between representations and warranties; and
- the SPA contained limitations of liability under the warranties. If the warranties amounted to representations as well, these limitations would not apply to such misrepresentations and liability for them would not be limited, which would be “a strange and uncommercial state of affairs”.
It is also worth noting that, as is usual, the SPA contained an exclusion of liability for any matter of which the buyer was “actually aware”. The judge held that SBL had not acquired actual knowledge of the facts giving rise to the breaches of warranty just because members of the MBO team (who were aware of the relevant facts) then became directors of SBL: a director’s knowledge is not automatically imputed to his appointing company.
The case confirms that the status of warranties and representations is a matter of contractual interpretation, so clarity in drafting is of paramount importance. All language relating to representations should be excluded from an SPA if the intention is to do this. Also a properly drafted “entire agreement” clause should specify that claims for innocent or negligent misrepresentation based on wording in the SPA are excluded.
SHARE PURCHASE AGREEMENT: restrictive covenants not in restraint of trade
Cavendish Square Holdings BV v El Makdessi concerned the sale to a minority shareholder, CBV, of a large advertising and marketing communications group operating in the Middle East, by two individuals, M and G, who had been primarily responsible for the group’s success. At the same time, M was appointed a non-executive director and non-executive chairman of the company for eighteen months and agreed to provide on-going support to the company.
The share purchase agreement (SPA) imposed restrictive covenants on the sellers, including a broadly drafted non-compete clause covering involvement in a competing business and the non-solicitation of senior employees, which would last for around eight years if there was no breach by the buyer. By the end of 2010, CBV discovered that M had acted in breach of the restrictive covenant and in breach of his duties as a director of the company.
CBV brought an action against him for breach of the SPA and for breach of fiduciary duty. The claim for breach of duty was settled, but the claims relating to breach of the SPA were defended by M who claimed:
- that the non-compete covenants amounted to an unreasonable restraint of trade and were unenforceable; and
- that other clauses entitling the buyer, in the event of breach of the non-compete covenants, not to pay future instalments of consideration and to exercise an option requiring M to sell the remainder of his shares to CBV at a price based on net asset value, were unenforceable penalties.
The court upheld the validity of the covenants on the grounds that:
- although CBV had to establish the reasonableness of the restraints, this was not a heavy burden given that there was substantial goodwill in the business and substantial consideration had been paid;
- the clause had been negotiated by experienced lawyers for both parties on a level playing field;
- CBV was entitled to ensure that it was protected from competition by M in relation to the matters set out in the relevant clause;
- the drafting of the covenants was not uncertain; and
- the minimum duration of the covenant of eight and a half years could not be considered too long. It was linked to the deferred acquisition of M’s minority holding, and was not an unreasonable period of protection for CBV. The court also noted that there is no case in which an otherwise reasonable covenant of this type has been found to be unreasonable due to its duration.
The court also found that the clauses entitling the buyer not to pay future instalments of consideration and to require exercise of the option over M’s remaining shares did not, together or separately, amount to unenforceable penalties. They were commercially justified by adjusting the consideration between the parties based on a loss of goodwill. The thorough negotiation by experienced commercial lawyers meant that the clauses were not oppressive nor, because of the way the clause operated, were they extravagant. Equally, their predominant purpose was not to deter a breach, and they were negotiated on a level playing field.
It is important to note that neither EU nor US competition rules applied to this sale and that where this is the case additional restrictions will be relevant and need to be complied with. However the case shows that where these rules do not apply and, providing agreement is reached on a level playing field, the courts will be reluctant to find this type of provision invalid. It is, however, important to consider the strength of the parties’ respective bargaining positions and the value provided for restrictions accepted by the seller.
A final point is that this case has no bearing on the validity of restrictive covenants in employment contracts, since in these cases an inequality of bargaining power between the parties is assumed and, in order to be valid, restrictions are likely to need to be much shorter.
ENFORCEABILITY OF JUDGMENTS IN CROSS-BORDER INSOLVENCY PROCEEDINGS
The Supreme Court has recently given judgment in two appeals concerning an important issue in international insolvency law, which is the extent to which the English courts will recognise and enforce judgments obtained by a foreign insolvency office holder. In the case of Rubin v. Eurofinance SA the office holders were US bankruptcy trustees appointed under Chapter 11 and in the case of New Cap Reinsurance Corporation v. Grant, the office holder was the liquidator of an Australian company.
The Court of Appeal had held that the relevant foreign judgments could be enforced because (following the earlier Cambridge Gas case) this type of judgment fell neither within the “in rem” nor the “in personam” categories of judgments determining proprietorial and personal rights respectively. The judgments could therefore be categorised as falling within the Court’s common law power to give assistance to foreign insolvency processes.
The Court of Appeal’s decision caused practical problems because entities that failed to participate in foreign insolvency proceedings would be at risk since any judgment given against them in such proceedings could then be enforced against them in the English courts.
The Supreme Court overturned the Court of Appeal decision and held that insolvency judgments do not fall into a special category, and that a foreign insolvency judgment will only be enforced in the English courts if the usual common law rules relating to recognition and enforcement of foreign judgments apply. These require that the judgment debtor was present in the foreign jurisdiction when the proceedings were instituted, that he claimed or counterclaimed in the proceedings, or that he voluntarily appeared in them, thereby submitting to the jurisdiction, or that he had previously agreed to submit to jurisdiction. In the Rubin case this meant that the judgment could not be recognised or enforced in England because the respondents took no part in the proceedings and were not present in the US. In the case of New Cap, however, the judgment could be recognised and enforced. New Cap had submitted proofs of debt in the Australian liquidation and had taken part in creditors’ meetings, which amounted to a choice to submit to the Australian insolvency proceedings and were, as a result, to be taken to have submitted to the jurisdiction of the Australian court supervising the proceedings.
The decisions in the Rubin and New Cap appeals have been generally welcomed as confirming settled common law on the enforcement of judgments, and removing some of the uncertainty caused by the Cambridge Gas case. However, what constitutes submission to jurisdiction is likely to be the subject of further discussion by the courts and it remains to be seen whether the decision will be followed in other key common law jurisdictions, particularly in Asia.
PIERCING THE CORPORATE VEIL: recent Supreme Court discussion
In the recent case of VTB Capital plc v Nutritek International Corp and others, the Supreme Court declined to extend the circumstances in which an English court will pierce the corporate veil.
The case involved a dispute between VTB Capital plc (VTB) and a Russian company (RAP). VTB advanced $225 million to RAP to buy some dairy companies from Nutritek International Corporation. RAP subsequently defaulted on the loan repayments and VTB then alleged that it had been induced to enter into the facility agreements by fraudulent misrepresentations made by Nutritek. These included a representation that RAP and Nutritek were not under common control when, in fact, they were both owned by a Russian businessman, Mr. Malofeev. VTB argued that the corporate veil should be pierced, allowing it to pursue a claim for breach of contract against Mr. Malofeev.
Under English law, it is an established principle that a company has its own separate legal personality, distinct from that of its members. However, in very limited circumstances, the courts will look through the corporate veil in order to hold those who control the company personally responsible for the company's acts. The common theme in the case law is that there must be some impropriety linked to use of the company structure to avoid or conceal liability.
In 2012, a controversial decision by the Court of Appeal in Antonio Gramsci Shipping Corporation v Oleg Stepanovs, allowed piercing of the corporate veil so as to bind a shareholder and a company to a contract entered into by only the company. This was on the basis that the shareholder had acted as a "non-contracting puppeteer" and was “pulling the strings”.
The Court of Appeal in the VTB v Nutritek case declined to follow the approach taken in Gramsci. Lord Neuberger, giving the unanimous judgment on this issue in the Supreme Court, agreed with the Court of Appeal's ruling.
Both the Court of Appeal and the Supreme Court emphasised the limited scope of the doctrine of piercing the corporate veil which has been developed pragmatically to provide solutions to problems arising in particular circumstances and ruled that this case fell outside those circumstances. In particular, the nature of contracts as consensual arrangements between the parties meant that the corporate veil should not be pierced in order to impose contractual obligations on third parties.
This decision is likely to mean an end, for the foreseeable future, to further attempts to impose contractual liability by piercing the corporate veil. It is also noticeable that, like the Court of Appeal, the Supreme Court chose to confine its decision to the narrow grounds of the case and explicitly avoided the question of whether and if so when the doctrine of piercing the corporate veil applies, apart from circumstances where the language of a statute expressly or implicitly permits it.