Indemnity and warranty claims - what you need to know

Emma Bufton: Hello my name is Emma Bufton and I am a Senior Associate at Gowling WLG. I also co-chair Thinkhouse Foundations. Thinkhouse Foundations is a network for in-house lawyers at the start of their careers where we provide tailored training, development and resources exclusively for paralegals, trainees, and lawyers of up to five years PQE. At our most recent Thinkhouse Foundations event, Senior Associate, Tom Cox, from our Commercial Litigation Team spoke about indemnity and warranty claims and gave his insight into what you need to know when dealing with these types of claims. He then spoke about how actions and misrepresentation played into this subject.

Tom, you are a litigator, why have we got you into talk about warranties and indemnities?

Tom Cox: Thanks for that ringing endorsement Emma. The reason I believe I'm here is that I am the one who has to deal with things when they go wrong and in that respect I am I think pretty well placed to comment on both drafting warranties and indemnities and what to do when a claim arises.

Emma: I suppose that does make sense so you handle claims brought under contractual warranties and indemnities. Those kinds of claims have a reputation for being pretty complex. Would you say that is fair?

Tom: It is certainly correct to say that there is an awful lot of case law borne out of warranty claims and indemnity claims which suggest that they can be somewhat problematic, but I think a lot of those cases have been generated by, dare I say it, sloppy drafting as opposed to any particular legal complexity and they might have been avoided altogether had those involved been a little bit more aware about the importance of what they were doing.

Emma: Sloppy drafting eh. I am not sure that comment will make you popular with any draftsmen listening to this.

Tom: Indeed. I suppose I ought to qualify the statement by pointing out that as a litigator I only see things that have gone wrong so maybe a huge number of warranty claims being brought and resolved successfully over which I and the remainder of the profession are largely unaware. The point that I wanting to make though is that most of the issues experienced can be traced back to the way in which the contract was drafted in the first place and/or to the way in which its requirements are misinterpreted.

Emma: OK, so let us rewind a little in that case. What is it that is special about warranty claims and indemnity claims?

Tom: Well the short answer is not much. Essentially they are just contractual claims. There is no real magic to it. The only really key distinguishing feature is that the acquisition contracts in question, we are really talking about share purchase agreements, SPAs in this context. They often place restrictions on what losses can be recovered. So if you are bringing a claim, you need to be alive to those restrictions and any associated hoops that need to be jumped through. For example, a typical restriction on recovery might be a limit on the time in which a party has to bring a claim. Owing to a seller's desire to be able to move on past the transaction with a degree of certainty, it is common place for the parties to agree to reduce the limitation period for bringing a warranty or indemnity claim so they might for example agree that the buyer has to notify the seller about the existence of a claim within 18 months of completion of the transaction and then issue proceedings within a further six months, otherwise it will be debarred from bringing a successful claim. That is a pretty common type of provision in the context of warranty and indemnity claims, but I suppose it is not something you would ordinarily see in other types of contracts.

Emma: Well that does not seem so complex given that the parties have agreed to it, so I do not see what the problem is.

Tom: Well you are right. There should not be a problem in principle with these provisions and yet issues often do arise because the drafting is not sufficiently clear or because the parties do not read the contract properly.

Emma: OK let us start with the drafting then as you are clearly banging on about that. Can you give us an example that you have come across?

Tom: Well let us take the timing restriction we have already talked about. If the parties agree that the buyer has 18 months from completion in which to notify the seller of its possible claim, then I would hope that we should not have any problems as that is a pretty easy provision to document, but it might be that rather than setting an arbitrary period for notification based around completion, the buyer wants the notification clock to start running only when it has discovered the issue in question to avoid a situation where it is debarred from a claim simply because the issue is not discovered for over 18 months. Such provision is absolutely fine provided that the drafting reflects that intention but what sometimes happens is the parties do not entirely think through what it is they actually want. The drafting ends up being a little bit loose leading to argument later down the line over for example whether the notification clock started when the buyer actually became aware of the issue or when it should have been aware of the issue having been provided with all the necessary information. As I said, issues like this should be evidently avoidable but I think at times drafters do not realise the extent to which these provisions may end up under the microscope.

Emma: OK well I can see that sloppy drafting might cause some confusion but surely this cannot generate that much litigation. Is something like this that big a deal?

Tom: Unfortunately you would be surprised. The reality is that in a lot of cases an argument over the timings or content of a notification amounts to the seller's last chance of avoiding liability so if there is any argument that can be had, they will seize on it. Consequently you will find that the majority of warranty and indemnity claims reported will actually be about notification as opposed to the underlying claim because otherwise the sellers will just be bang to rights.

Emma: So the same issues arise over the content of notifications?

Tom: Yes. it is the same point really. The contract will normally provide for the timing in which the notification needs to be given and the information that needs to be provided and if the buyer fails in either of those requirements, it will be debarred from bringing a successful claim. Consequently the same point around the clarity of drafting applies. You need to make as clear as possible what form of notification is needed or you are paving the way for satellite litigation in the future. Where at best the buyer is going to be delayed from resolving the underlying claim by having a spat over notification and at worst it is going to lose its claim altogether. So when you are drafting notification provisions you need to make sure that both parties are clear about what is required and that the contract reflects that clarity.

Emma: Have you got any practical tips in that respect?

Tom: Well obviously it is up to the parties to agree what they want to agree but, wherever possible, I really recommend trying to simplify matters. For example, if there are multiple sellers the parties might want to think about appointing an agent for the purpose of receiving notifications to save the buyer needing to serve each seller at different addresses potentially all around the world. Similarly, the parties might want to agree something around what happens if a seller changes address. It would make sense for the seller to be obliged to update the buyer but that sometimes is not thought about which might lead to confusion over what needs to happen when it transpires the seller has moved to Greenland. Ultimately if the parties can think of any way to simplify matters and reduce the scope for an argument, it can only be a good thing.

Emma: Are you sure you are not just scaremongering to convince clients to send us more work?

Tom: Honestly I am really not. The Courts have shown time and again that they will construe notification provisions strictly and are well prepared to strike out claims if notification requirements have not been complied with. There was an excellent example of this in the Commercial Court very recently. The case in question is that of Zayo Group International Limited and Ainger and Others and it was heard in July of this year, with judgment handed down just within the last month. I am not going to go into all the details but in short the proceedings arose out of a warranty claim under and SPA following the sale of a business supplying a fibre-optic network. Under that contact the buyer was required to serve notice of its warranty claim on all of the sellers within 18 months of completion. Otherwise the sellers would avoid liability. On the last possible day before the deadline as often seems to be the case, a courier was despatched to effect service and it was subsequently agreed by all parties, successfully delivered the notice to six of the seven sellers. However in the case of the last seller, although the courier arrived well in advance of the deadline, he failed to deliver the notice as required by leaving it at the relevant address for service. What actually happened was that on arrival at the address in question the courier was informed by the owner of the property that the seller no longer lived at that address but had moved to New Zealand. Rather than posting the notice through the letterbox as he is required to do under the contract, the courier turned away and went home which in turns out was a pretty big mistake. Despite some imaginative arguments around whether the seller had frustrated service by not updating the buyer as to her address the Court found that under the terms of the contract the buyer had failed to serve all the sellers and therefore that in the absence of proper notification, it was bound to fail in all its claims. As such the claim was struck out and the sellers walked away without liability.

Now that may seem pretty brutal but it is also a pretty perfect example of the strict approach that the Courts will adopt and therefore how important (a) it is to ensure that notification requirements are clear and easy to follow; and (b) that when you are called upon to give notice they satisfy every requirement into the letter to ensure that there can be no arguments over whether or not you comply.

Emma: Wow that does seem rather harsh.

Tom: Indeed but it is for that reason I am afraid that people get rather nervous around warranty claims.

Emma: So what do you do if the notification provisions are not clear?

Tom: Pray. No I am only joking. The best advice I can give here is to take every precaution to ensure that you have complied. If that means serving notices absolutely everywhere you may have to do it. You are better off safe than sorry in this regard.

There is one further serious comment that I would like to make on this and it is around the level of detail that needs to be provided. This is often one of the most argued over points. The starting point is of course to do what it says in the contract but it is a bare minimum and if the contract is silent I think at the very least you need to firstly identify the warranty or indemnity under which the claim is going to be brought, and secondly provide the seller with sufficient information so that they can investigate the claim.

Emma: OK well that is really useful Tom thank you.  I suspect that you have scared everyone listening sufficiently. To wrap up if you had to give one piece of advice to clients on the subject what would it be?

Tom: I am going to cheat if I may and give one piece of advice to the drafters and one to those who are still looking to bring the claim. To the drafters, I would simply reiterate that you need to try to keep everything as clear and simple as possible so basically just draft the provisions better. For those who might need to bring a claim, you need very quickly to check the time limits and then to take every precaution when drafting the notification. There is nothing worse than having a really good viable claim and not being able to bring it because you are either out of time or you have not read the contract closely enough.

Emma: Thanks very much Tom for those insights which I hope everyone listening has found useful. If you do need any further guidance on anything raised in this Podcast, then please do contact Tom at tom.cox@gowlingwlg.com. Thank you.