In the recent case of Belfairs Management Limited v Sutherland the Court of Appeal examined how far the scope of a warranty may extend.
Invariably share purchase agreements contain warranties which are used by the buyer to gain assurances about the company they are purchasing. The seller must then go through the painstaking process of considering each warranty in detail and make disclosures against the warranties in order to limit its liability to the buyer.
In the above case Mr and Mrs Sutherland disposed of 60% of their shares in Waveform Solutions Limited (a supplier of communications and information technology solutions) to Belfairs in 2008 for £2m.
The commercial rationale behind the sale was that the company was under capitalised and needed further investment to take advantage of its opportunities. In particular the company had, in 2007, submitted a tender to the NHS to work on the NHS National Programme for IT and had received an "intention to award letter" nominating it as one of only eight successful parties invited to sign an agreement with the NHS.
When Mr Sutherland approached Belfairs he projected the future investment of the company excluding income from the NHS agreement. However, in an early draft of the sale proposition and in correspondence with Belfairs lawyers, Mr Sutherland made various statements as to the value of the NHS contract. All the statements were removed in the later drafts of the proposition.
Mr Sutherland also made it clear to Belfairs that the additional investment was necessary to take advantage of, and fulfil, the NHS contract.
Belfairs completed the acquisition of 60% of the share capital of Waveform in February 2008 and the Sutherlands re-invested 50% of their consideration in the company by way of loan. Later that month, as envisaged by both parties prior to completion, the NHS contract was executed.
It quickly became apparent that substantial work was needed for the company to meet the NHS milestones and in September the NHS rejected Waveform's proposal. The following day Belfairs asserted a breach of the following warranty in the share purchase agreement:
"The Company is not a party to any agreement, arrangement or commitment which ......cannot readily be fulfilled or performed by it on time."
In November 2008 Waveform was placed into administration.
The question before the Court was whether or not the NHS agreement, which was unsigned at the point of completion but which both parties understood to be key, constituted an 'agreement, arrangement or commitment' of Waveform at the point of completion and therefore fell within the ambit of the warranty.
The Court of Appeal held that, in the context of the nature and purpose of the transaction between the defendants and Belfairs, there was no sound reason that the NHS agreement should not be held to be an agreement which fell within the scope of the warranty.
So what does this mean?
The Court has once again demonstrated its willingness, when faced with two alternatives to construction of a contractual provision, to construe it in favour of the commercially sensible outcome. Clearly, the significance of the NHS contract in the context of the transaction supported the Court's decision to reject the literal meaning of the words used in the warranty.
However, the decision will have an impact on the disclosure process and, in order to protect themselves fully, sellers will need to take a much broader approach to making disclosures.
Sellers should avoid considering warranties in isolation but should attribute to them the widest possible meaning, taking into account, as the Court did in this case, the context in which the transaction is taking place and any matters which are of significance to the buyer.
Case: Belfairs Management Limited v Sutherland & Sutherland  EWCA Civ 185