In this article we consider the English law position in respect of the measure of damages for breach of warranty, and the implications for W&I insurers.
Counter parties to Share Purchase Agreements (SPA), most commonly the buyer, are increasingly turning to Warranty and Indemnity (W&I) insurance policies. The measure and quantification of damages for breach of warranty under a SPA can produce different results depending on whether a contractual or tortious measure is applied. This directly impacts upon insurers’ exposure under a W&I insurance policy and is often the source of coverage disputes.
The distinction between warranties and representations
It is customary for SPAs to contain certain factual statements given by the seller as to the business and operations of the target company, the breach of which will entitle the buyer to make a claim against the seller. Buyers will often seek to frame these statements as “representations and warranties” in order to maximise the potential damages that are available to them, since tortious damages and contractual damages may be available in this instance.
The importance of the distinction between the two legal concepts was highlighted in the case of Sycamore Bidco Ltd v Breslin & Anor  in which the buyer tried, unsuccessfully, to establish that the warranties in a SPA also constituted representations:
“The point has a real significance in terms of the measure of damages (and also the date at which damages should or can be assessed), …. If the claimants are right about it, and can otherwise put their claim successfully in misrepresentation, then they may be entitled to recover damages which would not be available under a contractual claim…...”
Contractual damages vs tortious damages - why does it matter?
As a general rule, the remedy for breach of warranty in English law will be limited to contractual damages, which aim to put a party into the position it would have been in had the contract been performed. This involves an assessment of the difference between the value of the target company as warranted and the value of the company due to the breach (ie, the diminution in the value of the company due to the breach). Contractual damages are subject to the normal rules on remoteness and the buyer will be able to recover losses arising naturally, according to the normal course of things, from the breach; and losses as may reasonably be supposed to have been in the contemplation of the parties at the time they entered into the contract.
Tortious damages, on the other hand, aim to put a party into the position it would have been in had the breach not occurred (ie, if the buyer had not bought the company at all). Tortious damages are assessed by reference to the difference between the actual price paid for the target and the value of the company as represented. In principle, a wider scope of “consequential” or indirect damages is available under the tortious measure.
These two assessments can often result in the same quantum of damages, since the Court may consider that the actual price paid equates to the market value of the target company as warranted. However, they can produce very different results depending on whether the Insured has made a good or a bad bargain.
- buyer paid £50m for target company
- target worth £55m as warranted (ie buyer has made a good bargain)
- breach of warranty means target is actually worth £45m
- contractual measure of damages = £10m (ie the difference between the value of the company as warranted (£55m) and the value of the company due to the breach (£45m)), and
- tortious measure of damages = £5m (ie the difference between the actual price paid for the company (£50m) and the value of the company due to the breach (£45m)).
If, in the context of the scenario above:
- target was worth £48m as represented (ie buyer made a bad bargain by paying £50m)
- contractual measure of damages would then be limited to £3m (ie the difference between the value of the company as represented (£48m) and the value of the company due to the breach (£45m)), and
- tortious measure of damages would remain the same, at £5m, as above.
In summary, if a buyer made a good bargain, it may recover greater damages from the seller under the contractual measure of damages; whereas if it made a bad bargain, the tortious measure of damages might produce a more favourable result for the buyer.
What this means for underwriters
Underwriters should be aware of the potential impact that the applicable measure of damages can have on their exposure under the policy. When assessing the risk, underwriters should pay particular attention to any losses that are excluded under the SPA. They may wish specifically to stipulate in the policy that an indemnity will be provided on the basis of a particular measure of damages or exclude particular types of loss, for example, consequential or indirect losses which may include loss of profits.
Coverage disputes typically arise as to the quantum of indemnity that should be provided to an insured and underwriters may seek to argue that a particular measure of loss or quantification methodology is more appropriate in the circumstances. It is therefore important that underwriters are familiar with the distinction between the contractual and tortious measures.
Whilst it is not the subject of this article, underwriters should also bear in mind that the measure of damages can differ greatly from jurisdiction to jurisdiction. By way of just one example, in the US the measure of damages is usually awarded on an indemnity basis, giving dollar for dollar compensation to the buyer and, therefore, a far wider measure of damages than the position in England.
This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.