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A recent case has illustrated the importance of ensuring that indemnities in share or asset purchase agreements are drafted as clearly as possible, according to a leading company lawyer.
“It is usual for a purchaser of a company or business to incorporate into the acquisition agreement a detailed set of warranties from the seller regarding the state of the target. A purchaser can potentially claim damages for a breach of any such warranties”, says Philip Round, a corporate partner at George Green LLP, with particular experience of transactions in the financial services sector. “Most prudent purchasers, however, regard warranty claims as a last resort, given the expense of formal litigation, and usually attempt to flush out potential problems prior to completion through appropriate due diligence.”
Mr Round continues, “any issues identified in advance by the purchaser, which are clearly attributable to the seller’s default, tend to be covered off through an upfront purchase price adjustment or a requirement for the seller to indemnify the purchaser on a pound for pound basis against any losses which may arise.”
In the recent case of Wood v Sureterm Direct Ltd & Capita Insurance Services Ltd, the Court of Appeal was required to interpret an indemnity in a share purchase agreement against any claims arising out of mis-selling by the target insurance broker.
Mr Round explains, “a claim was made under the indemnity in respect of mis-selling prior to completion. Such misconduct was originally discovered and reported to the Financial Services Authority (now the Financial Conduct Authority) by the target’s own employees, as they are required to do. The court held that the entire indemnity was qualified by a specific reference to losses arising out of claims and complaints registered with the regulatory authority. This prevented a claim by the purchaser, given that the loss arose out of mis-selling reported by the business itself rather than a third party claim.”
“In arriving at its decision, the court emphasised that whilst it is required to interpret a contract in accordance with common sense and not in a pedantic manner, this does not require it to reject the clear and natural meaning of a clause even if, with the benefit of hindsight, one of the parties has negotiated a particularly bad bargain.”
Mr Round concludes, “a purchaser who has unintentionally agreed a restrictively worded indemnity should not automatically expect a court to rectify his error, by applying a commercial interpretation, where the clause is unambiguous. It is therefore crucial for a seller and purchaser to instruct lawyers with experience in advising on complex transactions. This is particularly true in the financial services sector, where the purchase price formula commonly necessitates intricate drafting, and contractual indemnities are often required to address specific regulatory risks.”