Warranty claims: to what extent are post-transaction events relevant?
CYK Partner Sam Roberts, Counsel Mikhail Vishnyakov, Senior Associate Kajal Patel and Associate Emily Davies look at the recent decision made by the English High Court in Equitix EEEF Biomas 2 Limited v Fox  EWHC 2531 (TCC), examining the difficulties with applying a mitigation clause in breach of warranty claims.
In breach of warranty claims, recoverable losses are typically assessed by reference to the position as at the date of the breach. However, the claimant may be required, by a mitigation clause (which is often included in SPAs) to take steps to mitigate its losses. The assessment of the claimant’s compliance with that clause is therefore concerned with events which occurred after the date of the breach.
The English High Court considered this difficulty in Equitix EEEF Biomas 2 Limited v Fox  EWHC 2531 (TCC). The High Court held that the duty to mitigate imposed by the mitigation clause could be applied in an “appropriate” breach of warranty claim.
However, on the facts of the case, this clause was not breached, and the High Court therefore only offered generic guidance as to how this clause may be applied. Although that guidance is welcome, considerable uncertainty remains.
Interestingly, the English High Court also used this opportunity to set out some of the other circumstances in which events after the date of the breach may be relevant to assessing recoverable loss in warranty claims.
- The Claimant purchased the entire shareholding in Gaia Heat Limited (“Gaia”) pursuant to a share sale agreement in August 2016 (the “SSA”). Gaia was contractually obliged to supply steam to Greenergy Biofuels Limited (“Greenergy”) but failed to produce sufficient steam to meet its obligations. Greenergy terminated the steam supply contract with Gaia in November 2017.
- The negotiations of the SSA took place against the backdrop of Greenergy’s complaints (to Gaia) regarding insufficient supplies of steam, as well as Gaia’s complaints (to the manufacturers of the boilers) regarding the poor condition of the boilers (allegedly impeding Gaia’s steam production). These pre-existing problems (which were insufficiently disclosed) gave rise to various breach of warranty claims.
- The Court held that various warranties contained in the SSA were breached.
Approach to loss assessment in breach of warranty claims
The Court upheld the established principle that damages in breach of warranty claims consist of the difference in the value of the shares as warranted (i.e. had the warranties been true) and their true value (i.e. the value taking into account that such warranties were false).
- Value as warranted: the Court upheld the assumption that the price paid is the best evidence of the value of the shares “as warranted”. That price was £14.45 million.
- True value: this required an analysis of what a “hypothetical open market purchaser” would be willing to pay, knowing that the warranties were false. That price would have been £1 million.
The Claimant’s loss was therefore £13.35 million, capped by the SSA at £11 million.
Failure to Mitigate
- The mitigation clause required the Claimant to take “all reasonable action to mitigate any loss”. The Court recognised that in a normal share valuation case, the loss “has already crystallised at the point of purchase” and therefore the common law duty to mitigate does not operate in a normal breach of warranty claim (429).
- However, the Court held that the mitigation clause should not be limited to applying to the SSA the common law duty to mitigate losses. This would have rendered the mitigation clause redundant. Accordingly, that clause meant that despite the typical method of assessing damages in a breach of warranty claim, the mitigation clause imposed a duty to mitigate on the Claimant.
- The Court held that the mitigation clause would have required the Claimant to take action which it would be unreasonable not to take (441). On the facts, the Claimant did not breach that clause and it therefore did not require any reduction to the Claimant’s damages.
- The Court therefore did not need to consider precisely how that clause would operate to reduce damages in a breach of warranty claim. The Court acknowledged that although it is not “easy to devise” a method for calculating that reduction (444), the Court should assess that reduction “as best as it can, having regard to the duty, the extent of the breach and the justice of the case” (445).
- The broad nature of this guidance means it remains to be seen precisely how a breach of duty to mitigate could reduce recoverable damages in breach of warranty claims.
Circumstances in which subsequent events may be relevant
The Court considered the circumstances in which subsequent events may be relevant to assessing the recoverable loss in a breach of warranty claim.
- Warranties as to “process” rather than as to “quality”
If the warranty breached is one of “process”, subsequent events may be relevant. An example of a warranty as to “process” would be a financial forecast warranted to have been prepared with reasonable care. If it has not been so prepared but the claimant cannot show that it would have acted any differently had the forecast been prepared with reasonable care, then no recoverable loss may have been suffered.
However, warranties as to “quality” (e.g. as to the state of the boilers) did not require an assessment of subsequent events. Furthermore, the fact that presence of some warranties breached were as to “process” did not mean that the Claimant was not entitled to the full measure of damages for breach of warranties of “quality”.
- Other examples of circumstances in which subsequent events may be relevant
The Court (briefly) set out examples of other situations where post-transaction events may be relevant.
These situations include:
- Subsequent events are to be used as a “cross-check” to test the reasonableness of forward- looking estimates relevant to the share valuation exercise.
- In an “exceptional case”, it may be possible to consider subsequent events if ignoring them would lead to a “windfall for the buyer” (423).
- It may be possible to take into account supervening events if the valuation exercise depended on a future contingency.
The application of these principles would be an interesting step, given this may involve a departure from the traditional approach explained above.
This case demonstrates the difficulties with applying a mitigation clause in breach of warranty claims. It also remains to be seen precisely how a mitigation clause could operate to reduce damages in a breach of warranty claim. That said, this case provides a useful analysis of the role of the mitigation clause in breach of warranty claims, as well as a helpful overview of the circumstances in which post-completion events may be relevant in assessing damages in breach of warranty claims.