The English Court of Appeal finds that a defective notice of breach can ruin the prospects of a successful claim

In this update we discuss the English Court of Appeal's judgment in Decision Inc Holdings Proprietary Ltd v Garbett and El-Mariesh [2023] EWCA Civ 1284, which was handed down on 3 November 2023. The judgement addresses: (i) the interpretation of a material adverse change clause ("MAC clause") in an SPA; and (ii) whether or not a notice of claim for breach of warranty, purportedly served in accordance with the SPA's terms, was in fact valid.

The Court of Appeal's judgment serves as a useful reminder of the importance of strict compliance with contractual notice provisions and the dangers of serving a defective notice, which might ultimately result in a good claim being struck out. 

The judgment also illustrates that parties involved in contractual negotiations should exercise extreme caution at the drafting stage in considering whether their preferred interpretation of a particular term (in this case "the prospects of the company") will be sufficiently clear to be accepted by a Court.  Where a clause stipulates a specific reference point against which a company's performance is to be assessed or measured, the contract should clearly set out and describe what that reference point is.  In this case, the Court of Appeal did not accept that "prospects" equated to EBITDA, in circumstances where the relevant clause referred only to "prospects" and not to EBITDA.

Background

The dispute concerned the sale of a company, then known as Copperman Consulting Limited (the "Company"), which specialises in the design of enterprise performance management.

Pursuant to the terms of an SPA dated 8 October 2018, the Defendants (Mr Stephen Garbett and Mr Anis El-Mariesh) agreed to sell to the First Claimant (Decision Inc Holdings Proprietary Limited ("Decision Holdings")), the issued shares in the Company. Decision Holdings subsequently assigned its rights and benefits under the SPA to the Second Claimant (Decision Inc Shareco (RF) Proprietary Limited ("Decision Inc")).

Prior to signing the SPA, Decision Holdings' founder and chief executive met with the Defendants on various occasions throughout 2018 during which time the Defendants supplied information relevant to the Company's financial position, including the sales "pipelines" for various months. These included anything from a remote prospect to a concluded agreement. 

The SPA contained various warranties in relation to the Company. In particular:

1. pursuant to Warranty 19, the Sellers warranted that since the Accounts Date (defined as 31 December 2017) "there has been no material adverse change in the turnover, financial position or prospects of the Company" (emphasis added); and
2. pursuant to Warranty 20, the Sellers warranted that all financial and other records of the Company "(i) have been properly prepared and maintained; (ii) constitute an accurate record of all matters required by law to appear in them, and in the case of the accounting records, comply with the requirements of section 386 and section 388 of the CA 2006; (iii) do not contain any material inaccuracies or discrepancies; and (iv) are in the possession of the Company…".

Pursuant to Clause 10.2 of the SPA, the Defendants warranted that "except as Disclosed" each of the warranties set out in Schedule 4 to the SPA was true as at the date of the SPA and 12 October 2018. 

Clause 11.4 stated:

"The Sellers shall not be liable for a Claim unless notice in writing summarising the nature of the Claim (in so far as it is known to the Buyer) and, as far as is reasonably practicable, the amount claimed, has been given by or on behalf of the Buyer to the Sellers…". (emphasis added)

"Claim" was defined by clause 1 to mean "a claim for breach of any of the Warranties in Schedule 4".

After the Company was sold, Decision Holdings found that the Company's revenue was significantly lower than had been expected based on the monthly accounts and statements provided by the Defendants during the due diligence stage.

On 6 March 2019, Decision Holdings and Decision Inc wrote to the Defendants alleging breach of the SPA's warranties.  Following that, on 4 September 2020 Decision Holdings and Decision Inc gave formal notice (the "Notice") of a claim pursuant to the terms of the SPA. Proceedings were issued in the Chancery Division of the High Court on 2 October 2020.  Critically, the Notice did not provide a breakdown of the amount claimed in respect of each claim referenced.

In those proceedings, the Claimants alleged:

1. breach of Warranty 20, on the basis that the Company's "records" were defective;
2. breach of Warranty 19, on the basis that there had been a "material adverse change in the turnover" of the Company; and
3. breach of Warranty 19, on the basis that there had been a "material adverse change in the…prospects" of the Company (the "Prospects Warranty").

First instance judgment

At first instance, Mr Simon Gleeson (sitting as a Deputy High Court Judge) found in favour of the Claimants in respect of their claim for breach of the Prospects Warranty and awarded damages of £1.31 million.  The remainder of the claim was dismissed.

When assessing the claim for breach of the Prospects Warranty, the Judge held that it was necessary to work through three stages to determine whether the Prospects Warranty had been breached:

1. Step 1: determine what prospects had been forecast when the parties signed the SPA – i.e., the expected or forecast level (the "baseline figure");
2. Step 2: determine the actual position as at the date of the SPA (the "actual figure"); and
3. Step 3: consider the difference between the baseline figure and the actual figure, and assess whether that difference is so great as to be material.

The Judge found that there was a material difference between these two figures, and therefore concluded that the Defendants had breached the Prospects Warranty.

The Defendants appealed to the Court of Appeal.

Court of Appeal judgment

In a judgment given by Lord Justice Newey on behalf of the Court of Appeal, Newey LJ set out the issues which arose from the appeal, which in summary were:

1. was the Judge's interpretation of, and approach to, the Prospects Warranty wrong? ("Issue 1");
2. should the Judge's order be set aside on the basis that the breach of the Prospects Warranty (which he held had taken place) did not reflect a claim pleaded or argued by the Claimants? ("Issue 2"); and
3. did the Notice give adequate notice of a claim for the breach of the Prospects Warranty which had been determined in the Claimants' favour at first instance. In particular, was it necessary for the Notice to include the amount of each claim for which notice was being given? ("Issue 3").

Newey LJ also identified two further issues ("Issues 4 and 5"), which were not ultimately determined due to the Court's findings made in respect of Issues 1, 2 and 3, above.

As explained below, the Court of Appeal found unanimously in favour of the Defendants in respect of Issues 1, 2 and 3.

Issue 1

The Court of Appeal concluded that the Judge's interpretation of, and approach to, the Prospects Warranty had been wrong, for the following reasons:

1. the Judge had used the wrong dates when assessing whether or not there had been a breach. By comparing the baseline figure with the actual figure as at the date of the SPA, the Judge had incorrectly approached the question of whether there had been a breach of the Prospects Warranty. The correct approach was to evaluate the Company's prospects from the Accounts Date (31 December 2017) against its prospects when the SPA was signed in October 2018;
2. the Judge had made the wrong comparison. The Prospects Warranty required a comparison of the same thing (i.e., "the prospects of the company") to be made on different dates, rather than comparing different things (i.e., the baseline figure and the actual figure) on the same dates;
3. the Judge had applied the wrong reference period. Whichever criteria was used to assess the "prospects", the term looks to the future. The Judge, however, incorrectly focussed on EBITDA for 2018 to determine the Company's prospects, even though more than nine months had passed by the time the SPA was concluded. This meant that, to a great extent, the Judge was assessing whether the prospects warranty had been breached by reference to a historic period rather than a future period; and
4. by equating "prospects" with EBITDA, the Judge had used the wrong data against which to measure the Company's prospects. "Prospects" should be understood to mean "chances or opportunities for success". Had the parties intended EBITDA to be the relevant measure when drafting the Prospects Warranty, they could have been expected to use the term specifically, particularly given that the term "EBITDA" featured elsewhere in the SPA in a number of places.

Issue 2

Although Issue 2 is discussed at length in the Court of Appeal's judgement it was predominantly a procedural matter.  However, the Court of Appeal held that even if the first instance Judge was right in holding that the Defendants had breached the Prospects Warranty (which he was not), the findings did not reflect the Claimants' pleaded case and it would have been necessary for the Claimants to amend their Particulars of Claim, and the Defendants would have been entitled to ask for time in which to consider the implications of the new case.

Issue 3

The Court of Appeal confirmed that the Notice was not adequate. The Court of Appeal agreed with the Defendants' submission that in order for the Claimants to be able to pursue a claim for breach of the Prospects Warranty, the Notice had not only to include a summary of each claim but also, insofar as reasonably practicable, the amount claimed in respect of each claim (as expressly required pursuant to Clause 11.4). However, the Claimants' Notice had only included reference to the total amount of the claims it was pursuing.  The Court of Appeal therefore found that in circumstances where the Notice was deficient, the Defendants could not be held liable for any such breach.

Issues 4 and 5

Due to the above findings, it was not necessary for the Court of Appeal to determine Issues 4 and 5.

Comment

The Court of Appeal's judgment demonstrates the difficulties that can arise in disputes concerning MAC clauses, particularly where there is ambiguity or uncertainty as to the reference point against which the relevant change should be measured. The risk of a dispute arising can be reduced significantly by ensuring that MAC clauses are well-drafted and use unambiguous (and preferably defined) words or phrases – although that is often "easier said than done" when a provision is subject to heavy negotiation (as MAC clauses often are).

The judgment also illustrates the importance of ensuring strict compliance with contractual notice provisions – and the dangers of non-compliance.  The notice provisions of any contract deserve close scrutiny and parties seeking to serve contractual notices should ensure that any and all requirements stipulated within the notice provision (and the contract generally) are satisfied in full, particularly in the context of termination or breach notices.