Warranty Notices: A trap for the unwary?

Buyers wishing to make a claim under contractual warranty provisions must ensure strict compliance with notice requirements within share purchase agreements (SPAs) – particularly in relation to the timing and contents of a notice of claim.

Questions of compliance frequently arise in breach of warranty litigation. Whilst every notice of claim turns on the particular provisions of the SPA, this article provides some guidance on commonly negotiated aspects of notice provisions and identifies issues to be alive to when drafting SPAs or preparing a warranty claim notice, with reference to recent English court decisions.

 

Introduction: Warranties and notice provisions in SPAs

In a share acquisition, the buyer acquires a company which has its own assets, liabilities, contractual rights and obligations. There is therefore a risk that the buyer is acquiring a company that has undisclosed liabilities or future obligations that could reduce the value of the company at a later date. A buyer typically mitigates those risks by carrying out due diligence on the target company and obtaining warranties in the form of contractual assurances from the seller as to the condition or state of the target company.

A breach of a contractual warranty gives rise to a claim for breach of contract. This affords the buyer different rights compared to:

1. breach of a representation, which usually gives rise to a claim of misrepresentation; and 
2. a claim under an indemnity in which the buyer is generally entitled to be reimbursed by the seller in respect of a liability that arises as a result of a future event (for example, losses that arise as a result of ongoing litigation that is yet to be concluded).

Before bringing a warranty claim, SPAs usually require the buyer first to notify the seller of the claim, including the alleged cause of action and loss, within an agreed timeframe. In Dodika Ltd v United Luck Group Holdings Ltd [2021] EWCA Civ 638 (Dodika), Popplewell LJ described the purpose of a notice of claim as being to “enable the recipient to make inquiries into the factual circumstances giving rise to the claim with a view to gathering and preserving evidence, assessing the merits of the claim … and to take into account the nature and scope of the claim in its future business dealings whether by way of formal reserving or a more general assessment of the potential liability”.¹ Notice provisions promote "finality and certainty in commercial dealings", so "the parties can close their books on the transaction"².

Should a buyer not comply with the relevant provisions, the warranty claim notice may be invalid under the terms of the SPA, with the claim being barred. It is therefore imperative that parties take care when negotiating notice provisions and, when a warranty claim is being made, review them properly before sending a notice (if you are a buyer), or after having received a notice (if you are a seller).

 

Practical points for negotiating, interpreting and complying with warranty notice clauses

Notice requirements are a creature of contract and commercial parties are generally free to negotiate and agree their terms. Drafters should bear in mind that, on questions of interpretation, whilst the starting point will be to consider the language used, ambiguities will be resolved by a narrow construction given that warranty clauses are essentially exclusion clauses. It is therefore important for warranty notice clauses to be drafted clearly and precisely.

Commonly negotiated aspects of warranty notice clauses include:

• Limitation periods: Absent an agreement to the contrary, the default period during which a warranty claim is actionable is six years from breach if the SPA is signed as an agreement or 12 years if executed as a deed. However, almost invariably, the parties agree to truncate the period within which warranty claims are required to be notified to the seller in the interests of ensuring commercial certainty. This is usually a few months after the target company’s second audit following completion as any issues will likely already have become apparent by that point. Sellers are usually motivated to negotiate a shorter limitation period (for example, following completion of the first audit).³ Any time periods should be clear and specific.
• Contents of notice: In addition to setting a period within which warranty claims must be notified, warranty clauses usually specify certain information requirements as to form and contents of a buyer’s notice of claim. In order to enable the sellers to make an informed assessment of the details and merits of the claim, warranty clauses usually require the notice to set out the particulars of the matters giving rise to the claim, the nature of the claim and an estimate of the amount claimed. As discussed below, a number of recent decisions have shown that the courts will uphold the rights of sellers to insist on strict compliance with specific warranty clause notice requirements (although, if the requirement serves no commercial purpose and merely introduces a trap to defeat a valid claim, it is unlikely to be upheld⁴). When negotiating, buyers should therefore seek to ensure that any notice requirements are clearly drafted and limited and, where possible, agree with the seller that compliance with content requirements is not a condition precedent to the seller’s liability.
• Serving the notice: Most SPAs contain provisions setting out precisely how and on whom contractual notices must be served. Parties should ensure that such service provisions are clear and practicable. For example, a requirement to serve by facsimile can present difficulties for a buyer.
• Obligation to progress notified claims: Once notified, buyers may lose the right to pursue a warranty claim if proceedings are not subsequently commenced in respect of that claim within a specified period following the notification (with the SPA usually specifying a number of months). Care is required when drafting to avoid debate around when the time period commences and whether the requirement extends to both filing a claim and effecting service. From a practical perspective, a buyer will seek to negotiate a period which allows them adequate time to further investigate and draft the claim form.

Whether a warranty notice is sufficient to meet the requirement of a clause depends primarily on the language of the clause. A buyer looking to bring a warranty claim should:

• Check the time limits for serving a notice and bringing a claim, ensuring this is kept front of mind when investigating the potential claim.
• Avoid waiting until the very last moment before issuing a notice of claim. If the notice of claim is defective in any way or is not properly served before the deadline, there will be no time to correct those defects. By the same token, buyers shouldn't rush unduly into issuing a notice and ensure the matter is properly investigated and the notice is compliant.
• Ensure that all content requirements are complied with. Whilst there are varying levels of details required under each SPA, this may include: (i) making clear the type of claim that is being brought; (ii) identifying the SPA provision that has been breached (i.e. if providing notice of a breach of warranty, the notice should precisely identify which warranty the buyer believes has been breached); (iii) explaining the grounds of said breach; and (iv) including details of the loss allegedly suffered.
• Serve the notice properly. For example, the SPA may set out specific requirements as to whom the notice should be delivered to and how it should be transmitted.
• Ensure that, once notification has taken place, any relevant pre-action steps are followed and that proceedings are promptly commenced.

Equally, a seller who has received a breach of warranty notice should examine whether the notice conforms with the notice and service requirements under the SPA, and consider whether it can knock out a claim on the basis of procedural non-compliance before proceedings are commenced in relation to the substantive dispute.

 

Notice requirements: Recent guidance

The Court of Appeal’s recent decision in Decision Inc Holdings Proprietary Ltd v Garbett and El-Mariesh [2023] EWCA Civ 1284 confirmed a long line of prior case law and reinforced the position that where there is a requirement to provide specific or reasonable information in warranty notice provisions in agreements, vague notices will not suffice. In that case, the buyer was required to include the "amount claimed" for each breach; providing an overall figure for all the alleged claims was not sufficient. The Court of Appeal therefore overturned the first instance decision and held that the sellers were not liable.

Similarly, in Teoco UK Ltd v Aircom Jersey 4 Ltd [2018] EWCA Civ 23, the Court of Appeal upheld the High Court's decision to strike out a claim for breach of warranty on the basis the seller was not notified of the buyer's claim in accordance with the notification clause of the SPA, which required notices be in "reasonable detail… including the grounds on which it is based". Lord Justice Newey interpreted this to mean the legal basis of the claim had to be set out in the buyer's notice to the seller. In that case, it was not sufficient for the buyer to frame the notice in a wide way in order to keep its options open.

In the recent decision in Drax Smart Generation Holdco Ltd v Scottish Power Retail Holdings Ltd [2024] EWCA Civ 477 (Drax), the Court of Appeal arguably took a more pragmatic approach. In that case, it was held that a buyer's notice of a warranty claim under an SPA was valid notwithstanding the seller’s arguments that the notice of claim did not comply with the content requirements set out in the notice provision by reason of it failing to state the precise legal basis upon which the calculation of the loss was made.

Background

The facts of Drax were as follows:

• Drax Smart Generation Holdco Ltd (Buyer) acquired the shares in a company (Company) from Scottish Power Retail Holdings Ltd (Seller).
• the Company had an asset which could be developed as a gas power station. The development of the power station necessitated the laying of cables over land owned by a third party, E.ON UK Plc (E.ON), in order to be connected to the national electricity grid.
• another entity within the Seller group (SPDCL) had entered into an option agreement with E.ON giving SPDCL the right to obtain an easement over the land which would enable cables to be laid (Option Agreement).
• as part of the SPA, the Seller warranted that the benefit of the Option Agreement would be assigned to the Company prior to completion.
• the sale completed and the Company attempted to exercise the option; however, it was identified that due to technical errors regarding the correct contractual entities, the Option Agreement had not been validly assigned to the Company, and the period in which to exercise the option had expired.
• the Company therefore did not have the benefit of the Option Agreement and did not have a right to lay cables over the land to connect any new gas power station to the grid. As a result, the Buyer sought to bring a claim against the Seller for breach of warranty, amongst other things including a claim under an indemnity, the details of which are not discussed in this article.

Notice of claim

Prior to bringing the claim, the Buyer was first required to serve notice of the claim on the Seller pursuant to the terms of the SPA. In particular, the Buyer was obliged to set out “in reasonable detail the nature of the claim and the amount claimed (including the Buyer’s calculation of the Loss thereby alleged to have been suffered)”.

The Buyer served a nine-page notice of claim on the Seller (Notice) that: (i) identified the Notice as a formal notice of claim; (ii) set out the relevant background; (iii) highlighted the relevant provisions of the SPA; (iv) identified the various respects in which it contended it had a claim against the Seller; and (v) explained that the loss was “yet to crystallise”, but “where possible” gave an estimate of the potential loss that was likely to be suffered.

Details of the anticipated losses were presented in a similar way in the Buyer’s subsequent particulars of claim, in addition to setting out the losses suffered by the Company up to the date of issuing the claim, for example, in negotiating the option rights. After serving the Notice and issuing proceedings, the Buyer requested permission to amend its claim to provide for the loss being “the diminution in the value of the Company caused by the Defendant’s breaches of the SPA”.

The Seller denied liability but, in any event, contended that the Buyer’s claims were barred because the Notice did not comply with the requirements of the SPA. In particular, the Seller claimed that “the nature of the claim and the amount claimed” had not been sufficiently notified in the Notice as the Buyer had not referred to the diminution in the value of the shares in the Company as the calculation of losses. As the Notice was served on the last day provided for under the SPA, this meant the Buyer was time-barred from serving a new Notice.

Decision of the High Court

There were two applications before the judge: (1) an application by the Seller for summary judgment; and (2) an application by the Buyer for permission to amend the Particulars of Claim, which both turned on whether the reformulated claims in the draft Particulars of Claim had a real prospect of success.

The judge found that the Notice had identified the claims but had not provided reasonable detail of the losses for which the Buyer was claiming. In particular, the notice requirements in the SPA required the Buyer to identify that its claim was based on the diminution in the value of shares in the Company if that was the basis on which it intended to rely for the purpose of calculating loss. The Buyer appealed this finding.

Decision of the Court of Appeal

In reaching its decision, the Court of Appeal noted that where general terms such as 'the nature of the claim' and 'in reasonable detail', are used, "those requirements should be interpreted in the light of the commercial purposes of such clauses, including those identified in Dodika" (as to which, see above). Males LJ further commented that notification clauses should not become "a technical minefield to be navigated" and that "the courts should not interpret such clauses as imposing requirements which serve no real commercial purpose unless compelled to do so by the language of the clause."⁵

The Court of Appeal accepted that it was impossible to read the Notice as advancing a claim based on the difference in value of the shares, but it did not consider that this was necessary for the purpose of complying with the notice provisions in the SPA. The Court saw nothing in the language of the SPA which required the Buyer to spell out, as part of a statement as to the nature to the claim, that the damages sought would be based on the difference in value of the shares; to introduce such a requirement served no commercial purpose and would merely introduce a trap to defeat an otherwise valid claim. For the purpose of the notice clause, it was sufficient for the Buyer merely to state that Seller had failed in its obligation to ensure that the Company had the benefit of the Option Agreement. This would have told the Seller all it needed to know to investigate the claim and obtain legal advice.

With respect to the amount of the claim, all that was required by the Notice was a statement of “the amount claimed (detailing the Buyer’s calculation of the Loss thereby alleged to have been suffered)” which, in the Court’s view, “must refer to a calculation put forward in good faith”⁶. As the Buyer’s good faith in formulating the losses in the way it initially did was not challenged, what was put forward in the Notice was indeed the “Buyer’s calculation of the Loss thereby alleged to have been suffered”. The Notice was therefore found to have satisfied the requirements of the notice provisions in the SPA and the Buyer’s appeal was allowed.

 

Conclusion

Whilst the Court of Appeal took a pragmatic approach in Drax and found that the requirements should be interpreted in light of the commercial purpose of the clause, parties should remain cautious and remember that the courts have consistently been willing to adopt principles of strict interpretation to warranty notices, for example in finding that vague notices will not suffice where there is a requirement to provide specific or reasonable information. Where notice provisions are ambiguous, caution is required to avoid falling foul of the notice requirements. Ultimately, each notification clause turns on its own individual wording; this makes it vital that parties negotiate and draft notice provisions clearly and that they are revisited when preparing (or receiving) a notice to ascertain precisely what is required to give a valid notification. A failure to do so could be catastrophic for a buyer’s warranty claim.

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¹ Dodika, paragraph 46.
² Drax Smart Generation Holdco Ltd v Scottish Power Retail Holdings Ltd [2024] EWCA Civ 477, paragraph 49.
³ The limitation period for tax warranty claims is typically longer because those tax liabilities are often not known for a number of years.
⁴ Drax, paragraph 55.
⁵ Drax, paragraph 50.
⁶ Drax, paragraph 56.