‘Representations And Warranties' Made Clear - Guaranteed!

In corporate acquisitions, references to 'representations and warranties' abound. Even though these terms are sometimes used interchangeably, (perhaps as shorthand), in law 'representations' and 'warranties' are quite different. A recent case illustrates just how important the difference between the two can be, with more than US$ 500 million turning on it.

Idemitsu Kosan Co Ltd v Sumitomo Corporation [2016] EWHC 1909 concerned the sale of a company holding licence interests in two North Sea oil and gas fields (Ross and Blake). Idemitsu, the buyer, claimed damages for misrepresentation against Sumitomo, the seller.

Hybrid representations and warranties?

Pursuant to a sale and purchase agreement of November 2009 (the "SPA"), Idemitsu had paid Sumitomo US$ 575 million for the company. Idemitsu alleged that certain matters that Sumitomo had warranted in the SPA then turned out to be untrue. The difficulty for Idemitsu was that under the SPA, all claims for breach of warranty had to be notified within 18 months. Idemitsu had missed that deadline, and it was common ground that all claims for breach of warranty under the SPA were, therefore, barred.

Idemitsu instead claimed on a different basis. Idemitsu argued that all the matters that were warranted in the SPA were also, independently, pre-contractual representations. It went on to state that these statements had induced it to enter into the contract. Idemitsu claimed that, since these representations were false (as Sumitomo knew), it was entitled to damages for misrepresentation. On that approach, the maximum that Idemitsu could claim was the amount paid for the company - US$ 575 million. Most importantly, however, misrepresentation claims would not be caught by the contractual time-bar in the SPA.

In Idemitsu, the High Court found that the statements that were warranted in the SPA did not also take effect as pre-contractual representations. In so concluding, the High Court refused to follow another conflicting first instance decision which had found that warranties were also effective as representations - but that hybrid nature is now seriously to be questioned. In this article, we consider these decisions - starting first with an overview of the underlying legal principles.

"Caveat emptor"

At common law, the general rule is, of course, 'caveat emptor' - buyer beware. This applies when purchasing a car for U$ 5,000 as much as it does when purchasing a company for US$ 500 million. Simply by acquiring the company, Idemitsu had not 'purchased' (as the judge put it) the benefit of any promises by Sumitomo about the state of the company, its assets, liabilities, profitability or ability to carry out business. That is why sale and purchase agreements generally include warranties. But a buyer may acquire some protection outside of the contract, in tort, if the seller makes any actionable representations before the contract is entered into.

Representations - liability for false statements

In English law, there are three types of misrepresentation, depending on the state of knowledge of the person making the statement: fraudulent, negligent and innocent misrepresentation. All these require a false statement of present fact, or as to a belief or an opinion held by the person making the statement. The law in this area is partly governed by statute, in the form of the Misrepresentation Act 1967.

At common law, the tort of deceit applies to fraudulent statements. Deceit (or 'civil fraud') does not require any dishonest motive. In Eco 3 Capital Ltd v Ludsin Overseas Ltd [2013] EWCA Civ 413, the Court of Appeal confirmed that an intention to deceive is not a prerequisite of the tort of deceit. As regards the mental state of the defendant, it is sufficient that they (i) either know that the statement is false, or are reckless as to whether it is true or false, and (ii) intend that the claimant should rely or act on the basis of the statement. As was noted in the famous case of Derry v Peek:

"... if fraud be proved, the motive of the person guilty of it is immaterial. It matters not that there was no intention to cheat or injure the person to whom the statement was made."

Short of fraud, claims for negligent misrepresentation are often framed under Section 2(1) of the Misrepresentation Act 1967, because of a reversal of the burden of proof that gives claimants an advantage. If the statement in question is in fact shown to be false, then it is for the person who made the statement to prove that they had reasonable grounds for believing that it was true. In Howard Marine and Dredging Co Ltd v A Ogden & Sons (Excavations) Ltd [1977] EWCA Civ 3, the Court of Appeal described the effect of the 1967 Act as follows:

"In the course of negotiations leading to a contract the statute imposes an absolute obligation not to state facts which the representor cannot prove he had reasonable ground to believe."

While English law allows the parties to negotiations to keep their cards very close to their chest, without imposing any duty to disclose matters to the counterparty (outside the realm of insurance contracts), it does require the parties to say only things that they could reasonably believe to be correct.

Damages for misrepresentation

A claimant can recover damages both for fraudulent and...