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A recent High Court case has illustrated the problems which can arise if parties do not carefully consider the wording of a contractual warranty, according to a corporate partner.
“A contract which is unambiguous but which makes no commercial sense and is impossible to enforce is likely to be held void for uncertainty” says Philip Round, who is based at George Green’s Wolverhampton office. “The High Court case of Kitcatt and others v MMS UK Holdings Ltd and others, is a good example of the risks of not thinking through the meaning of a clause”. Mr Round continues, “the case concerns the sale of an advertising agency to the defendant.
Under the agreement, part of the purchase price was deferred and payable by reference to the post completion performance of the merged business. The defendant warranted in the sale agreement that it was not aware of any fact which might result in a reduction in operating income or revenue during the earn-out period. The defendant was aware of the potential loss of a major client, which ultimately resulted in no consideration being payable. The claimant alleged that the defendant had breached the warranty”.
According to Mr Round, the defendant argued that the warranty was meaningless and unenforceable. “The contract did not specify a base line from which the percentage reduction could be calculated. Furthermore, operating income and revenue were defined terms, and referred to the actual financial performance for the relevant years, making the warranty circular and meaningless. In this instance, however, the court found that the parties had provided forecasts of the financial performance of the combined group which allowed an indication of the expected base line figures from which the percentage deterioration could be measured. The court held that the defined terms were not to apply to this warranty, particularly as the agreement stipulated that the definitions should only apply save to the extent that the contract otherwise required. The warranty was not therefore void for uncertainty”.
Mr Round concludes, “whilst in this instance the defective drafting did not invalidate the provisions, the costs of legal proceedings could have been avoided had the parties properly considered the meaning of the clause”.