Only Fools Or Liars? Breach Of Warranty Claims

A corporate financier might say that only a fool or a liar would find themselves on the receiving end of a breach of warranty claim after the sale of a business.

Arguably, a well-organised, properly advised vendor should be able to sell a business and be reasonably certain that a claim from the purchaser will not follow. But forensic accountants see plenty of cases where a breach of warranty is alleged and a claim is made.

Some of these claims arise due to completing deals in a hurry, or where the commercial desire to 'do a deal' has overridden the need to properly secure both parties' positions through the transaction documentation. Purchasers who choose to claim generally come across a number of stumbling blocks, some of which we consider here.

Damages

The measure of damages in a breach of warranty case will be the difference between the value of the business sold as warranted and its actual value.

It is often assumed that the value of a business sold as warranted is equivalent to the consideration paid. However, sometimes the warranted information supports a lower valuation than the consideration paid. The purchaser may have paid more for a number of reasons, such as their own projections of what the company could achieve in the future.

Understanding what valuation the warranted information would have supported should be the starting point to assess the damages that the purchaser could credibly recover.

Bases of valuation

Arguments over how a business was valued when it was acquired are likely to become central to quantifying potential damages. This was highlighted in Senate Electrical Wholesalers Ltd v Alcatel Submarine Networks Ltd [1999]. The claimant pursued damages in excess of £26m but the Court of Appeal awarded none, even though the court found for a material breach of warranty following an overstatement of profits reported in warranted management accounts.

This decision should serve as a reminder that the eventual outcome of a breach of warranty case may be a finding of a breach, but no loss. An unattractive prospect considering the time and expense involved in bringing such an action.

The claimant's own accounts - having it both ways?

When one company purchases another, the directors of the acquiring company may perceive, after the event, that what they bought is not worth what they paid. But how do they disclose this information in their accounts?

Accounting standards dictate that the identified loss should be recognised...