Warranty claims and tax investigations

The High Court has provided guidance on the notification of claims made under warranties, tax warranties and a tax deed in TP Icap Ltd v Nex Group [2021] EWHC 1375. The High Court struck out parts of the claimant's claim on the basis that its purported notice of a claim and subsequent claims under an SPA were either premature or ineffective.

The decision illustrates the difficulties of providing valid notification of potential claims under an SPA or tax deed where investigations arise but the results of that investigation are uncertain. It also highlights the importance of the precise terms of both the warranties and the provisions concerning claims involved.

Background

The claimant company acquired the target group from the defendants pursuant to the terms of a share purchase agreement (SPA) and with the benefit of a tax deed. The SPA contained a number of warranties given by the seller as to the existence of any disputes with governmental authorities. In particular, in Warranty 9.1 the sellers warranted that the target had not contravened any applicable law or regulation which had or may result in any fine, penalty or other sanction that would have a material adverse impact on the operation of the target’s business and in Warranty 9.2 the sellers warranted that the target was not subject to any non-routine investigation, review or enquiry by a Governmental Authority in relation to the target group business.

The tax warranties included warranties that no target group company was involved in any dispute or non-routine audit, review or investigation in relation to Taxation with a Taxation Authority and that no such enquiry or dispute was anticipated (Tax warranty 22.3) and that no target group company had participated in any transaction, scheme or arrangement of which the or a main purpose or effect is the avoidance or evasion of a liability to Taxation Tax warranty 22.9).

Following the acquisition, the US Commodities and Futures Trading Commission and the UK Financial Conduct Authority commenced enquiries and investigations into the trading activities of members of the group. In addition, German authorities commenced an investigation relating to allegations of tax-related criminal offences in relation to cum-ex trading.

Accordingly, the claimant provided two written notices, the trading investigation notice dated 20 December 2018 and the tax investigation notice dated 29 December 2018, purporting to notify claims for breach of warranties 9.1, 9.2, 22.3 and 22.9. Following notification, it commenced proceedings for damages for breach of contract [and for a payment under the terms of the tax deed]. The defendants applied to strike out the claims on the basis that the claimant had not properly notified its claims in accordance with the terms of the SPA, had misconstrued the tax warranties or that the claims were premature.

Decision of the court

The SPA contained a notification clause in paragraph 5.1 which provided that: “The Seller is not liable in respect of a Seller Warranty Claim unless the Purchaser has given the Seller written notice of the Seller Warranty Claim (stating in reasonable detail the nature of the Seller Warranty Claim and, if practicable, the amount claimed), but without prejudice to the rights and obligations of the parties under the Tax Deed:

• on or before the expiry of the relevant statute of limitation period in respect of [the Tax Warranties]; and
• on or before [30 December 2018]".

Paragraph 5.2 then provided a 12 month period for the actual bringing of a claim which had been notified under paragraph 5.1.

The Court held that paragraph 5.1 was a limitation clause and confirmed that the nature of what must be notified under paragraph 5.1 must be determined by reference to the terms of the warranty in question. The time limits in paragraph 5 were mandatory. It was up to the purchaser to decide when to notify and having been notified, a Warranty Claim was subject to a one year cut off period for the issuing and service of proceedings under paragraph 5.2. That was the commercial deal that the parties had struck and which provided certainty for the seller. It was not possible for the purchaser to seek to get those agreed time limits by notifying and then pleading "contingent claims" in the sense of claims which have not yet arisen and which may never arise.

In relation to the claim in respect of warranties 9.1 and 9.2, it would be necessary that the claimant provide a description of the broad nature of the contravention of the law or regulation that had occurred. It was not sufficient to notify a claim where it was dependent on a contingency. That was the position in this case since, whilst investigations had begun, there was no finding of any contravention at the point of notification. Under the terms of the SPA, it was not sufficient to simply notify within the relevant time limit that an unspecified contravention might come to light at some point in the future. Indeed, the language of the claimant's notice, particularly the use of "may", confirmed only that a claim might subsequently be lodged under paragraph 9.1. The notice had failed to assert that any specific claim was being made.

As such, the Court struck out the claim made under warranties 9.1 and 9.2. The court had no sympathy for the argument that the claimant could not positively assert that a member of the target group had contravened a law or regulation without that assertion having a damaging impact on the buyer's group.

In relation to the tax warranties, however, the High Court rejected the defendant’s strike out application. Essentially, the Court agreed that the wording of warranty 22.3 covered a target group company’s involvement in tax related disputes both in relation to its own affairs and in relation to the tax affairs of third parties. The use of the term "involved in" was much broader than "subject to", and the definition of Taxation was equally broad and not limited to Taxation of a target group company. It was understandable that the tax warranties might cover a target group’s involvement in tax avoidance or evasion schemes carried out by third parties as these might result reputational damage as well as financial liabilities. Equally, warranty 22.9 was not restricted to a target group company's participation in a tax avoidance scheme designed to avoid a tax liability of a target group company. The warranty extended to participation in a scheme of which a main purpose was the avoidance or evasion of a tax liability of a third party.

Tax deed

The High Court struck out the claimant's claim for an indemnity pursuant to the tax covenant because no actual tax liability had arisen and therefore the claim was inadequately pleaded and premature. The claimant argued that since issues concerning the German tax investigation were going to trial, then the court at trial should also be able to determine whether the types of liabilities sought to be imposed would amount to an Actual Tax Liability under the tax covenant and that the steps the buyer had taken and is taking to avoid liability should fall within the scope of the costs indemnity in that covenant. It was conceded that the position might have been different had the claimant pleaded the issues more specifically; in that case the court might have been able to determine issues hypothetically.

Comment

The decision illustrates the difficulties for buyers when investigations are commenced into target company activities post-completion. This will especially be the case where they are commenced close to the expiry limits in the SPA. While the earlier decision in Laminates Acquisition Co v BTR Australia Limited [2003] EWHC 2540 makes clear that contingent claims are possible, this decision highlights the limits of making contingent claims in the context of warranties for breach of laws and regulations. In particular, the notification must make it clear that a claim is being made (rather than might be made in the future ) and a general notification to the effect that "in so far as a contravention of an unspecified law (or even a specified law) is hereafter found in connection with a particular regulatory investigation to have occurred, then there is a breach of clause 9.1" would in any event be insufficient for these purposes.

In relation to the tax warranties, the decision highlights the importance of retaining longer time limits for tax. In addition, it is notable that the Court was prepared to construe the tax warranties widely as applying to any involvement in a tax avoidance scheme, whether or not there was any impact on the tax position of the target group

Taken together with the recent Court of Appeal decision in Teoco UK Ltd v Aircom Jersey 4 Ltd [2018] EWCA 23, these cases provides a stark warning concerning both the requirements for giving valid notice of a claims and the dangers of accepting a widely drafted requirement to provide notice of claims to the seller. In Teoco, despite providing lengthy details of the nature of the tax liabilities in the target companies, the purchaser was held not to have provided valid notice under the terms of the contractual arrangements since the relevant letters had failed to point out the particular provisions of the Tax Deed or particular tax warranties on which the purchaser based their claim.