Corporate update: the latest corporate law developments June 2024

Court of Appeal confirms validity of warranty claims notice

The Court of Appeal has overturned the decision of the High Court and held that a notice of warranty claim was valid and complied with the relevant requirements of a share purchase agreement (Drax Smart Generation Holdco Ltd v Scottish Power Retail Holdings Ltd [2024] EWCA Civ 477).

Notice of warranty claims

When giving warranties to a buyer under a share sale agreement, the seller will commonly negotiate contractual limitations on its liability under those warranties. Those limitations will usually include a requirement for the buyer to notify the seller of any potential claims within a specified period and for that notification to include reasonable details of the claim and how it has been calculated. Failure by the buyer to comply with these requirements may result in the claim being unenforceable and the seller avoiding liability, regardless of the merits of the claim itself.

The courts have taken an increasingly strict (and some would say harsh) approach to the interpretation of claim notifications, requiring a formulaic compliance with contractual provisions. The first instance decision in the Drax Smart Generation case provides a good example of this approach. However, the fact that the Court of Appeal has overturned that decision, and its reasons for doing so, may well indicate that the courts will adopt a more pragmatic attitude to these cases in the future.

Facts of the case

Drax had acquired a company (Target) from Scottish Power under a share purchase agreement (SPA), and subsequently brought a claim against Scottish Power for breach of a warranty in that SPA. The SPA required any notice of warranty claim to state, “in reasonable detail the nature of the claim and the amount claimed (detailing the Buyer’s calculation of the Loss thereby alleged to have been suffered)”.

Scottish Power applied to dismiss Drax’s warranty claim on the basis that Drax had failed to comply with the SPA notification requirements. The notice of claim had included the required calculation of Drax’s loss, but that calculation had been based on an estimate of the losses that Target was expected to suffer due to the warranty breach. Once legal proceedings had started, however, Drax had sought permission to amend its claim and base its loss on the reduction in value of Target’s shares arising from the warranty breach. Scottish Power alleged that Drax had claimed for a completely different type of loss than had been specified in the claim notice and, therefore, the claim notice was invalid.

The High Court agreed with Scottish Power, holding that Drax’s notice of claim did not give reasonable detail of the loss claimed (and how that loss had been calculated) and was, therefore, void. In the judge’s view, the fact that Drax’s claim had been based on the diminution in value of the Target shares was both part of the “nature of the claim” and also an essential part of the explanation required to provide the necessary “reasonable detail” of the amount claimed. This fact had not been included in Drax’s original notification of claim and, as a result, the claim had no real prospect of success. Drax appealed.

Court of Appeal decision

The Court of Appeal unanimously disagreed with the High Court and allowed Drax’s appeal on the basis that the notice of claim had satisfied the requirements in the SPA.

In relation to the “nature of the claim,” the Court held that Drax did not need to spell out that its claim was based on the diminution in value of the Target shares resulting from the alleged breach of warranty. Imposing such a requirement served no commercial purpose and would merely introduce a trap to defeat what may be a valid claim. All that was required was a simple statement that Scottish Power had failed to ensure that Target had the benefit of an option agreement (as it had warranted.)

As for the amount claimed, the Court found that Drax’s notice unquestionably stated the amount claimed and provided details of how it had been calculated. Even though Drax had not originally based its claim on the diminution in value of the acquired shares, the claim notice had set out Drax’s genuine (in good faith) calculation of the claimed loss, and that was all that was required. That genuine calculation did not have to be set in stone, and if further reflection indicated that the calculation was capable of improvement or was legally unsound, there was no reason to insist that Drax should be held to that method of calculation.

Comment

The Court of Appeal decision will be welcomed by buyers as it suggests that courts may be increasingly willing to interpret claim notices in a more pragmatic (and less legalistic) manner. The Court helpfully stated that notification clauses “should not become a technical minefield to be navigated, divorced from the underlying merits of a buyer’s claim”.

It is, however, difficult to reconcile some of the Court of Appeal’s findings with previous decisions. This is particularly so in relation to its conclusions on the “nature of the claim.” Previous cases have required buyers to identify the specific warranties that have been breached when setting out the nature of their claims, but the Court of Appeal was not convinced that this was necessary. Its conclusions suggest that, provided the recipient of the notice has enough information to assess or prepare for any impending claim, that should be sufficient.

Ultimately, whether a buyer’s notification of claim is found to be satisfactory will depend on the specific contractual requirements of the SPA. Despite this buyer-friendly Court of Appeal decision, buyers would still be well advised to err on the side of caution and provide as much information in their claims notices as they are reasonably able (based on the language of the relevant clause.) This is likely to include:

• the type of claim being brought (e.g. for breach of a warranty);
• what provisions of the contract are alleged to have been breached (identifying specific warranties where possible); and
• a genuine estimate of how any loss has been calculated.

Transfer of company assets at an undervalue amounted to unfairly prejudicial conduct

In Simpson v Diamandis and others [2024] EWHC 850 (Ch), the Court held that a company shareholder suffered unfair prejudice when the company’s sole director arranged for the sale of the company’s main asset to another entity owned by the director. The sale took place at a price significantly below the asset’s true market value.

Unfair prejudice

An unfair prejudice claim is the main procedural route for a minority shareholder to petition the courts when they believe that the company’s affairs are being conducted in a manner that is unfairly prejudicial to their interests. For the claim to be successful, the conduct complained of must:

• relate to “the company’s affairs” (which could include management decisions or disruptive attempts by shareholders to exert greater control);
• relate to members’ interests in their capacity as members; and
• must be prejudicial to the member and unfair.

The courts are more likely to find that conduct is unfairly prejudicial if the relevant company is a “quasi -partnership”. This may be the case, for example, where the company has been established based on mutual trust and confidence between the founding members, or where there is an understanding that all or some of the shareholders will be involved in the conduct of the business.

If a petition is successful, the courts are given a wide discretion to make any order they think fit to grant relief. In many cases, the petitioner will ask the court for a buy-out order where the other shareholders are required to buy out the petitioner’s shares at fair value.

The facts

Mr Simpson (the petitioner) and Mr Diamandis set up a company (AJH) in which each of them held 47.5% of the shares, with the remaining 5% held by AJH’s company secretary. Mr Diamandis was the sole director of AJH, but Mr Simpson was heavily involved in all strategic decision making. AJH subsequently acquired the shares in another company that had previously been owned by Mr Simpson (Subsidiary). Subsidiary was AJH’s most profitable asset.

Several years later, Mr Diamandis and a third-party investor, Mr Woollett, devised a scheme whereby the shares in Subsidiary would be transferred to a new holding company (Holdings). Under the initial plan, Mr Simpson and Mr Diamandis were to hold an equal number of shares in Holdings, but by the time the scheme was finalised, Mr Simpson had not been allocated any shares in the new company.

As the sole director of AJH, Mr Diamandis approved the board documentation for the reorganisation. AJH also passed a members’ written resolution approving the sale of Subsidiary to Holdings for £150,050. Mr Simpson had objected to the resolution, but Mr Diamandis and AJH’s company secretary together held sufficient shares to pass it.

Mr Simpson petitioned the Court on the basis that the shares in Subsidiary had been worth £2.9m at the date of transfer, considerably more than the £150,050 paid by Holdings. He claimed that the transfer of the shares at such an undervalue, to a company controlled by Mr Diamandis (and in which he himself had no shareholding), amounted to unfair prejudice. Mr Simpson also claimed that the transfer of Subsidiary at an undervalue was a breach of Mr Diamandis’ duties as a director and in breach of the quasi-partnership relationship that existed between Mr Simpson and Mr Diamandis.

The decision

The Court agreed with Mr Simpson, finding that he had suffered unfair prejudice as a result of the sale of Subsidiary to Holdings at a substantial undervalue.

In relation to its finding of prejudice, the Court held that the transfer of Subsidiary had resulted in the value of AJH (in which Mr Simpson still held shares), being reduced by approximately £2.75m. The Court noted that it was: “hard to conceive of a clearer example of the economic value of the petitioner’s shareholding being seriously diminished by reason of the conduct on the part of a person with de facto control of the company, namely, Mr Diamandis.” Mr Diamandis’ actions as sole director were properly regarded as the conduct of the affairs of AJH.

The Court also held that the prejudice suffered by Mr Simpson was unfair for several reasons. The business relationship between Mr Simpson and Mr Diamandis was based on mutual trust and confidence in each other – a quasi-partnership. It was a clear breach of that trust and confidence for Mr Diamandis to:

• deprive Mr Simpson of the value of his shareholding in AJH, whilst preserving the value of his own;
• cause AJH to sell its principal asset at an undervalue to benefit himself; and
• ignore professional advice and fail to obtain a valuation of the shares in Subsidiary.

In addition to breach of trust, Mr Diamandis’ actions had also constituted a breach of his fiduciary and statutory duties as a director of AJH.

The remedy ordered by the Court was for Mr Diamandis to buy out Mr Simpson’s stake in AJH.

Comment

This was a fairly straightforward case of unfair prejudice, particularly given the significant and obvious prejudice caused to the petitioner by the transfer at such an undervalue of AJH’s most valuable asset.

The case is still a useful reminder, however, that where individuals are in a quasi-partnership, additional equitable considerations will be taken into account and conduct may still be unfair even when carried out in what appears to be a procedurally correct manner. In this instance, the transfer at an undervalue had been blessed by an ordinary resolution of AJH’s shareholders, and its sole director had signed the necessary paperwork, but the transfer was still held to be unfairly prejudicial to Mr Simpson.

It is also interesting that the Court considered it appropriate to make a buy-out order against Mr Woollett, even though he was neither a shareholder nor a director of AJH. The Court found that Mr Woollett had colluded with Mr Diamandis in the restructuring scheme with the objective of obtaining a 15% share in Holdings. This was sufficient for the Court to make a secondary liability order against Mr Woollett (meaning that Mr Simpson could enforce the buy-out order against Mr Woollett, but then Mr Woollett could recover that money from Mr Diamandis).

First published in Accountancy Daily.