OFAC revokes so-called U-turn authorization for Cuba-related financial transactions
OFAC published a final rule that modifies the Cuban Assets Control Regulations to revoke the so-called "U-turn" authorization.
For some years, the sense has been that a significant proportion of the Commercial and Chancery Division’s time has been taken up by disputes arising from private M&A transactions. This is a broad category, covering not only breach of warranty, indemnity and price adjustment issues, but also claims involving tax covenants, fraud and other matters. Until recently, however, there has been little or no quantitative data on the incidence of this type of dispute.
In March 2017, one of the biggest warranty and indemnity (W&I) insurers globally, AIG, published its study on the incidence of claims notifications under policies that it had issued. A now well-established feature of M&A deals, W&I insurance provides cover to buyers and sellers for claims arising from breaches of representations and warranties given in the sale and purchase agreement (SPA). The results of AIG’s study with the latest edition due to be released in the coming months– now in its third year – are revealing. In the period covered by the study (policies issued from 2011 to 2015) the overall claims frequency was 18 per cent, up from 14 per cent, with claims being made under approximately one in four of policies issued for deals worth over US$1 billion. As these figures only reflect AIG’s (primarily) breach of warranty claims experience, it is not too much of a stretch to conclude that, annually, there must be large numbers of M&A disputes which are settled pre-action or when proceedings are on foot.
However, frequency of claims is only part of the story; it is also instructive to consider the types of issue which the Courts are being asked to consider. In this article, we attempt to do just that, by reviewing the reported cases in this area in the past two years.
Arguably the most high profile cases have concerned deferred consideration mechanisms. In the first such case, Starbev GP Ltd v Interbrew Central European Holdings BV  EWCA Civ 449, the question was whether the seller was entitled to a proportion of the profit realised by the buyer, when the business was sold on within a period of three years. The answer to this question had very considerable financial consequences: whereas the original sale price had been €1.475 billion, the on-sale price was €2.65 billion, with the seller claiming approximately €129 million of the difference. In addition to a number of clauses providing how the seller’s “Contingent Value Right” was to be calculated, the SPA contained an anti-avoidance clause. The buyer structured €500 million of the consideration due to the on-purchaser in the form of a Convertible Note, which it subsequently drew down on when the three year period had expired. The Court of Appeal confirmed that this transaction was caught by the antiavoidance clause on the basis it applied where the dominant purpose of the transaction was to reduce the seller’s Contingent Value Right.
In the same area, Team Y&R Holdings Hong Kong Ltd & Ors v Ghossoub  EWHC 2401 (Comm) concerned an SPA provision whereby, post-completion, any seller whose employment with the target company was terminated for acts of gross misconduct, or who engaged in a competing business, would lose his right to deferred consideration and be compelled to sell his retained shares to the buyer at a substantial discount (the “Defaulting Shareholder Clauses”). While this judgment concerned jurisdictional issues, the enforceability of the Defaulting Shareholder Clauses had already been considered by the Supreme Court in Cavendish Square Holding BV v Talal El Makdessi  UKSC 67. In that case, the other seller in the same transaction had argued that the Defaulting Shareholder Clauses were void and unenforceable as penalties. Having re-cast the law on penalties, the Supreme Court held that neither clause was a penalty (being neither a secondary provision nor intended to punish the seller).
Moving on to indemnities, Wood v Capita Insurance Services Ltd  UKSC 24 is another M&A dispute to have reached the Supreme Court, due to an argument by the buyer that the Court of Appeal had wrongly applied the recent Supreme Court guidance on contractual interpretation, falling into error by placing too much emphasis on the words of the SPA while giving insufficient weight to the factual matrix. The case is now cited as a leading contract law case, but the central issue was whether “an opaque provision which … could have been drafted more clearly” required the seller to indemnify the buyer for compensation which, post-completion, the FSA (as it was) required the target company to pay customers who may have been mis-sold insurance products. The other possibility, contended for by the buyer, was that only actual complaints triggered the indemnity. Having carefully examined the language used in the SPA, the Supreme Court found for the seller. Notably, Lord Hodge also observed that, in addition to the indemnity, the buyer had the benefit of time-limited warranties that the target company had complied with its regulatory obligations, which the buyer might have relied on but – for whatever reason – did not.
In First Names (Jersey) Limited & Anor v IFG Group Plc  EWHC 3014 (Comm), the question was again whether an indemnity had been triggered. In contrast to Wood, the construction of the indemnity clause was not in issue: it was a straightforward indemnity in respect of litigation and other proceedings arising from facts, matters or circumstances existing prior to completion. Instead, the main issue was whether the buyer had complied with (1) the notice requirements and (2) the time limit for starting proceedings after the contingent liability for which it was claiming became actual. The Court found for the buyer. However, on the breach of warranty side, there are a number of examples of buyers falling foul of similar notice clauses.
Where claims for breach of warranty are concerned, most – if not all – SPAs provide that claims must be notified within a specified period after completion, and that the notice must furnish the seller with enough information to understand the basis of the claim. There is also usually a further requirement that the buyer initiates court proceedings within a prescribed period after notification (typically a number of months). The judicially recognised commercial purpose of such clauses is to give the seller certainty not only that a claim may be brought, but of the grounds on which the claim is to be based. Strict compliance with contractual notice requirements is also not a trivial or technical matter, and the Courts give little latitude to buyers who serve a non-compliant notice, or fail to serve the notice in accordance with the SPA.
In 2015, in Ipsos S.A. v Dentsu Aegis Network Ltd  EWHC 1171 (Comm), the Court ruled – for the first time in a while – that an effective claim notice had not been served. This has now been followed by two further examples of buyers getting it wrong: in 2016, in Teoco UK Ltd v Aircom Jersey 4 Ltd & Anor  EWCA Civ 23, and in 2017, in Zayo Group International Ltd v Ainger & Ors  EWHC 2542 (Comm). In Teoco, the buyer’s notices were invalid because they did not purport to make a claim; rather, they indicated that the buyer had or may have claims which it might make in the future (a fine, but important, distinction). They also did not identify the warranties that had been breached.
In Zayo, by contrast, the buyer’s notices were found to be defective because they did not give a reasonable estimate of the amount claimed (as the notice clause required). The particular problem with the notices was that the sums claimed did not reflect the correct measure of loss for breaches of warranty (i.e. the diminution in value of the shares). The judge emphasised that this was not a technical point: a clear warning to those responsible for drafting claim notices that simply identifying the sums paid out, on a pound-for-pound basis, without referring to the proper measure of loss may cause serious difficulty.
It is also a common feature of notice clauses that they require the buyer to give notice “as soon as reasonably practicable” upon becoming aware that it has a claim, and sometimes within a specified period of days. This type of provision was addressed in both Nobahar-Cookson & Ors v The Hut Group Ltd  EWCA Civ 128 and Teoco. In Nobahar, the Court of Appeal stressed that a notification clause which imposes a contractual time limit is a species of exclusion clause, and therefore to be construed narrowly if ambiguous. It went on to decide (in favour of the buyer) that a clause requiring notice to be given “within 20 Days after becoming aware of the matter” meant that the buyer had to be aware of the claim itself, as opposed to the underlying facts. In Teoco, the Court applied the approach in Nobahar to find that the buyer – in addition to the invalidity of its notices – had failed to make its claims for various tax warranty breaches as soon as reasonably practicable after becoming aware of them.
In Zayo, however, there was a further issue arising from the manner in which the buyer had attempted to effect service on one of the Management Vendors. There, the SPA provided that none of the Management Vendors would have any liability “except in circumstances where the Purchaser gives notice to the Management Vendors before the date that is eighteen months of [sic] Completion.” When a courier tasked with delivering the notice to one of the Management Vendors on the last possible date for delivery, at the address given in the SPA, was told that the Management Vendor had moved, he opted not to deliver it. The Court rejected the buyer’s argument that, in such circumstances, the SPA contained an implied term that the buyer discharged its obligation by attempting to effect delivery, holding that the courier should have left the notice at the address in order to comply with the SPA’s service provisions. The Court also found that the buyers’ claims against the other Management Vendors (who had been served) were compromised, because the clause required all Management Vendors to be notified. While the result may seem harsh, it does very clearly demonstrate the rigour with which the Courts construe and apply notice clauses.
While notice clauses may have been prominent, substantive breach of warranty issues have also featured. Perhaps the best recent example is Kitcatt and others v MMS UK Holdings Ltd & Anor  EWHC 675 (Comm). There, the acquisition had been structured as an “earn-out”, meaning that the overall consideration to be paid to the sellers was linked to the performance of the target company (an advertising agency) post-completion. The buyer also gave certain warranties to the sellers confirming that they were unaware of any matters – including issues with customers – that might have a material adverse impact on the revenue of the business into which the target company would be merged (on which the earn-out thus depended). After the sale, the amount of work which the merged agency obtained from a major client reduced to such an extent that no deferred consideration was payable. The buyer sued the sellers, successfully overcoming a defence that the warranty was too uncertain to be enforceable. The Court also found that the breach of warranty was irrelevant, because a subsequent agreement had been reached that a specific amount would be paid to the sellers by way of deferred consideration, varying the SPA.
In addition to the issues already discussed, Zayo considered the effect of an exclusion on the Management Vendors’ liability “to the extent that provision or reserve in respect of the liability or other matter giving rise to the claim in question was made in the Accounts.” The seller’s position was that the exclusion applied regardless or whether the provision was or was not adequate. Perhaps surprisingly, the Court agreed, finding that the words “to the extent that” did not entail that the Management Vendors’ liability was reduced by the amount of the provision; a conclusion which possibly owed more to considerations of business common sense than to the words actually used. At this point, we should also briefly revisit the AIG study which gives a helpful breakdown as to the type of breaches of warranty relied on in the notifications AIG has received, the four main categories being: Financial Statements (20 per cent); Compliance with Laws (15 per cent); Material Contracts (14 per cent); and Tax (14 per cent). The far more limited number of breach of warranty cases covered in this article all fall into these categories: Financial Statements (Nobahar, Zayo), Tax (Teoco) and Material Contracts (Kitcatt – just about). Historically, Financial Statements warranties have been a particularly prominent feature of reported breach of warranty cases, and the recent claims experience – from AIG, more usefully, but also from the Courts – would suggest this trend is likely to continue.
Two tax covenant cases gave rise to Court judgments in 2017: Atheer Telecom Iraq Limited v Orascom Telecom Iraq Corp Limited  EWHC 279 (Comm), which went the distance, and Takeda Pharmaceutical Ltd v Fougera Sweden Holding 2 AB  EWHC 1402 (Ch), which was an application for an expedited trial or preliminary issue.
In Atheer, the SPA contained a covenant by the seller to pay any tax liability incurred by the target company – a telecommunications business – arising “on or before Closing”. Some years after the deal, the Iraq tax authority issued a number of tax demands and, while there was some doubt as to whether the assessments were properly made, the fact that they related to pre-Closing earnings meant that the covenant was engaged. Under the covenant, the seller was also required to pay tax demands for which the target company was “finally liable”, but the facts that (1) no tax had yet been paid and (2) the tax authority was not pressing for payment were held not to matter. There was also a question whether the buyer’s admitted dishonesty in related proceedings in Iraq engaged certain exclusions in the SPA. However, as the dishonesty came after the tax demands – and so had no causative effect – it was irrelevant.
As for Takeda, the situation at the time of the hearing (May 2017) was that the Danish tax authority had referred certain questions to the CJEU which could result in the target company facing a significant withholding tax liability. However, the tax covenant in the SPA was due to expire in September 2017 and, in order to reach an accommodation with the tax authority before that date, the buyer required certain information from the seller. The buyer was therefore pressing for the extent of the seller’s duties to provide information to be decided on an expedited basis or as a preliminary issue. The Court ordered the latter.
As these cases show, in recent times the Courts have seen a good number of M&A disputes, on a wide range of issues. There are also others which have not been considered here: for example CPL Ltd v CPL Opco (Trinidad) Ltd & Anor  EWHC 3399 (Ch) (concerning an alleged collateral contract, and whether it was caught by the SPA’s entire agreement clause) and Philp & Anor v Cook  EWHC 3023 (QB) (where a buyer tried to circumvent a notice clause by alleging a breach of warranty by way of set-off). All of these cases demonstrate that private M&A transactions continue to provide fertile ground for disputes, and for the development of English contract law (referring, in particular, to Cavendish and Wood).
As our corporate colleagues reported recently 1, despite considerable geopolitical and economic uncertainty, 2016 recorded one of the highest aggregate annual deal values in recent years. As for 2017, the statistics for the first nine months were less positive, but with variations in activity regionally and by sector, and M&A into the UK as high as it has ever been. With all of this activity, the historical experience suggests that 2018 will be another busy year for M&A disputes – perhaps more so as third party funding becomes an increasingly regular and familiar feature of the litigation landscape.
As for the types of dispute that we may see, in addition to the typically wide range of issues that is likely to emerge, it is possible that cyber exposures could become the next area of focus. Recent English case law has brought into focus the possibility of companies incurring substantial liabilities as a result of adverse cyber incidents. In 2016, Vidal-Hall v Google, Inc.  EWCA Civ 311 established that tort claims for misuse of private information and claims under the Data Protection Act may be brought even in circumstances where claimants have not suffered any pecuniary loss. More recently, in December 2017 the High Court found (in Various Claimants v WM Morrisons Supermarket plc,  EWHC 3113 (QB)) that a company can be held vicariously liable for data breaches caused by malicious employees in a broad range of circumstances (although time will tell whether this decision will survive the appeals process). Cyber incidents leading to liabilities of this nature may not be known to the parties – or their implications may not be fully understood – at the time of an acquisition. This make them potential fodder for M&A disputes once the deal has gone through and the implications of a cyber incident start to emerge. Disputes of this nature may centre around breaches of warranty or indemnity claims (to the extent specific warranties or indemnities are given in an SPA related to cyber risk or data security) or around consideration adjustments – recent high-profile data breaches at listed companies, for example, have demonstrated that cyber issues can have a significant impact on a company’s market valuation.
M&A Outlook, Norton Rose Fulbright LLP, January 2018
OFAC published a final rule that modifies the Cuban Assets Control Regulations to revoke the so-called "U-turn" authorization.
On 5 September 2019, Professor John McMillan AO’s Final Report (Report) on the operation of the Narcotic Drugs Act 1967 (ND Act) was tabled in Parliament. Section 26A of the ND Act required the Minster to cause a review of the operation of the ND Act to be undertaken.