Some Differences In Law And Practice Between U.K. And U.S. Stock Purchase Agreements

As M&A becomes increasingly international, historic differences between U.K. and U.S. practice are diminishing. The vagaries of the underlying legal considerations in each of the jurisdictions are responsible in part for the differences, but custom and practice play a major role in shaping the form and substance of U.K. and U.S. stock purchase agreements (or, to use U.K. nomenclature, share sale and purchase agreements). This Commentary focuses on differences in the following areas:

Whether "representations and warranties" or just "warranties" are given by the seller;

The standard of disclosure against warranties/representations;

The effect of the buyer's knowledge on its ability to bring a claim under the warranties;

Repetition of warranties/representations;

Material adverse change clauses;

Quantification of damages for breach of warranty/representation; and

Procedural and substantive matters relating to enforcement of claims/litigation.

Of course, in the U.S., except in certain limited circumstances, contract and tort law are matters of state rather than U.S. federal law. While there are broad similarities between the laws of the various states, there may be important differences.

Representations or Warranties?

In the U.K., it is common for the seller to resist giving representations as well as warranties and to delete the word "representation" from the agreement. The deletion of the term "representation" is considered, in some quarters, to minimize the risk of a tortious claim for damages under the Misrepresentation Act 1967 and to remove the possibility that the buyer will attempt to rescind the agreement ab initio under the provisions of that Act. In reality, the simple categorization of a statement as a warranty (without any further provisions) probably has little bearing on whether the statement is susceptible to being treated as a representation for purposes of that Act. Accordingly, a well-advised seller will always seek to exclude the remedies of tortious claims and rescission by express provision to that effect (see "Pre-Contractual Representations" below), rather than by arguing that those rights are excluded by virtue of simply characterizing the statement as a "warranty" and not a "representation."

It is customary in the U.S. for the statements regarding the target to be characterized as both representations and warranties. A U.S. court also is unlikely to find that a cause of action for misrepresentation does not exist just because a contract states that a party "warranted" a particular statement and did not "represent" it. As in the U.K., the nature of the remedies available to the buyer will depend, in part, on whether certain remedies have been contractually excluded and, in part, on the extent of the buyer's knowledge and reliance. In the Ziff-Davis case, 75 N.Y.2d 496 (1990) (see "Buyer's Knowledge" below), it was clearly demonstrated that a plaintiff may have a cause of action under contract law for breach of warranty, even if it knew that the matter being warranted was false. The buyer would not in such circumstances have a claim in tort for misrepresentation, as it would not be able to establish the necessary element of justifiable reliance on the statement in question; in order to do that, the buyer must have believed it to be true.

A well-advised seller in the U.S. will also seek to expressly exclude any tortious remedies available for misrepresentation. However, in contrast to practice in the U.K., the statements of fact are likely to continue to be characterized as "representations" and "warranties," even in circumstances where the parties expressly exclude tortious remedies that may otherwise be available for misrepresentation. This appears to be simply a matter of custom.

Pre-Contractual Representations.

In both jurisdictions, a seller will want to ensure that it cannot subsequently be found liable for representations and/or warranties that are not incorporated in the written agreement. Sellers therefore will invariably seek to include in the agreement an "entire agreement clause" and a provision to the effect that the buyer has not relied on any statement or promise not included in the written agreement (a "nonreliance statement"). Care must be taken in drafting such a clause in English-law-governed agreements if it is to have the desired effect. Realistically, in both jurisdictions, a well-advised buyer will take all steps to ensure that it has recorded in the written agreement all of the statements upon which it was seeking to rely and which had induced it to enter into the written agreement. It is no surprise, therefore, that a misrepresentation claim founded upon a statement that has not been included as a warranty in the written agreement is, so far as U.K. practice is concerned, quite rare. In the U.K., entire agreement clauses and nonreliance statements are hardly ever a matter of dispute.

However, in those rare cases where a buyer can demonstrate that it was actually induced by a pre-contractual statement (which had not been incorporated in the written agreement) to enter into the bargain, under English law, it may still have the ability to challenge the entire agreement clause and a nonreliance statement. In the cases of Thomas Witter Ltd v TBP Industries Ltd [1996] 2 All ER 573 and EA Grimstead & Son Ltd v McGarrigan [1999] WL 852482, the court held that an "entire agreement" clause alone will not exclude remedies for pre-contractual misrepresentations, and an acknowledgment of nonreliance can be challenged if in fact the buyer relied on a pre-contractual statement and was thereby induced to enter into the contract. The statement does not have to be the only inducement, but it must have been an inducement that was actively present in the buyer's mind when it agreed to enter into the contract (Edgington v Fitzmaurice (1885) 26 Ch. D 459).

In Witter the buyer relied upon certain pre-contractual statements that induced it to enter into the contract. The seller's defense was founded upon the following clause:

This Agreement sets forth the entire agreement and understanding between the parties or any of them in connection with the Business and the sale and purchase described herein. In particular, but without prejudice to the generality of the foregoing, the Purchaser acknowledges that it has not been induced to enter into this Agreement by any representation or warranty other than the statements contained or referred to in [the warranty schedule].

The court held that, on any literal interpretation, the first sentence of the clause could not operate as an exclusion of any remedies available at law for pre-contractual misrepresentation because the clause did not say that such remedies are excluded. To be effective, such a clause must therefore state expressly that the remedies the seller is seeking to exclude are excluded.

The court decided that even if a contract includes a nonreliance statement, the remedies in tort available for misrepresentation may nonetheless be available to a buyer. Section 1 of the Misrepresentation Act 1967 provides that, where a buyer has entered into a contract following a misrepresentation having been made to it, and

the misrepresentation has become a term of the contract, and/or

the contract has been performed,

the buyer is entitled to rescind the agreement. The effect is to preserve both tortious and contractual remedies even in circumstances where, in the absence of provisions to the contrary, the representation has become a term of the contract and the contract has been performed. Any seller should therefore expressly include in the agreement, in addition to the entire agreement clause and the nonreliance statement, a provision to the effect that the only remedies available to the parties shall be for breach of contract and that the buyer shall not have the right to rescind the agreement after closing.

In Grimstead, the Court of Appeal held, by way of obiter dicta, that a nonreliance statement could nevertheless operate as...