All the provisions of a share purchase agreement are important, but none more so than the warranties, the section of the document where the parties allocate risk; where the seller takes a deep breath and makes certain promises about the way the business being sold has been run and the buyer looks the seller in the eye to see if his gaze is true.
As feet are being held to the fire, it is right and proper that a great deal of effort is devoted to the promises (warranties) being given. Precision in the wording of the warranties is fundamental so the seller and the buyer are crystal clear about what is being promised. That is the theory anyway. Amazing to see that the Court of Appeal managed to get it so wrong in the case of Belfairs Management Limited v. Sutherland and Sutherland  EWCA Civ 185 reported recently.
In Belfairs, The respondents (the Sutherlands) owned a software company called Waveform which supplied products to the NHS. In 2007, Waveform succeeded in a bid to participate in the NHS National IT programme and this gave it the chance to enter into a framework agreement which, if certain milestones could be achieved by it within twelve months of entering into the framework agreement would allow it to bid for lucrative supply contracts with NHS primary care trusts. The Sutherlands were however aware that the milestones could not be met without significant further investment into Waveform. They therefore came up with a plan to sell a stake in Waveform to Belfairs, to recapitalise Waveform and only then with the benefit of that investment to enter into the framework agreement.
In early February 2008, the Sutherlands sold 60% of the shares in Waveform to Belfairs; Waveform was recapitalised; and a couple of weeks later, Waveform entered into the framework agreement.
As matters transpired, despite the recapitalisation, Waveform never met the milestones to enable it to bid for the supply contracts and severe financial trouble for Waveform ensued. Belfairs sued under the share purchase agreement pursuant to which it acquired a stake in Waveform, for breach of warranty. The relevant warranty stated:
“[Waveform] is not a party to any agreement, arrangement or commitment which cannot readily be fulfilled or performed by it on time.”
The question was: did the warranty apply to the framework agreement?
The Court of Appeal said that even though the framework agreement was only entered into after the share purchase agreement, it was still caught under the terms of the warranty. The Court said that objectively it should be assessed whether the warranty had been breached as the milestones had not been met on time, because a reasonable person would regard the reference in the warranty to “agreement” as including the framework agreement even though Waveform was under no compulsion at the time the share purchase agreement was entered into to sign up to the framework agreement and could have walked away from it.
How can this possibly be correct? The whole purpose of warranties is that they bite at a fixed point in time, when the share purchase agreement is signed. Are those warranties true at that moment or not? So important is the time reference that if the share purchase agreement is signed subject to conditions, the agreement will often contain a clause stating that the warranties are to be deemed given again on the day the agreement completes. So important is the time reference in the warranties, that the lawyers acting for a seller will go through the wording of the warranties and seek to strike out any language importing that certain events will or might be true at a future time as those things are obviously beyond the scope of what the seller can reasonably say.
Conceptually, it is also nonsense for a warranty given today to be capable of referring to an agreement which does not exist. Sure enough in common parlance when parties are preparing to enter into an agreement, they will refer to that agreement as a draft agreement, but that is as a matter of linguistic convenience. In reality, there is no such thing as an agreement until such time as it has been signed.
Interestingly, the Court of Appeal made the following finding (at para 45 per Rimer LJ):
“It might perhaps be said that Waveform had a non-binding ‘agreement, arrangement or commitment’ with the NHS to enter into the [framework agreement]. But even if that can be said, it takes BML’s case nowhere: it is not that non-binding ‘agreement, arrangement or commitment’ that was at the heart of the BML deal, but the [framework agreement] itself…”
Unfortunately, because the Court of Appeal talked itself into finding that the framework agreement was caught by the warranty, it neglected to consider arguably the more salient point which was raised in front of and rejected by the judge at first instance about the status of the unsigned framework agreement. Norris J in the High Court had ruled:
“I do not consider that the unsigned NHS Framework Agreement can be regarded as an “arrangement” or a “commitment” for the purposes of the warranty. At the transaction date Waveform had simply been selected as a party to whom an NHS Framework Agreement would be offered: it was not at that time subject to any obligation which had to be “fulfilled or performed by it on time…”
Surely Norris J was wrong to reach such a conclusion and that there can in fact be no better example than the unsigned framework agreement of an arrangement or commitment which is not actually an agreement. Both the High Court and the Court of Appeal appear to have overlooked the obvious point that the words “arrangement or commitment” must surely have been added by the draftsman of the warranty precisely to cover a situation or circumstances which fell short of being a legally binding agreement giving rise to obligations.
While in this particular case, the distinction will make little difference to the outcome, it seems to me that the case creates a very dangerous precedent for future transactions, by importing into the interpretation of warranties, factors and matters which are quite literally beyond the scope of what the parties can reasonably expect.