Any Purchaser would be delighted if told by their lawyer that on a breach of the warranties contained in the acquisition agreement they will receive a multiple of the loss suffered. However, when - if ever - is this likely to happen and what as a Purchaser should you be looking out for, or indeed telling your lawyer to negotiate for on your behalf?
General principles
Where there is a breach of warranty the general principle for the calculation of contractual damages is that the Purchaser is entitled to the difference between the value of the company or business as warranted and the actual market value of the company or business. The purchase price is generally taken as the warranted value, and the court, via court appointed experts, assesses the actual market value as at the date of completion applying one of the normal commercial bases of valuation.
Multiple damages
There are certain circumstances where a multiplier will be applied to calculate damages for breach of warranty, namely:
- where it is stated in the agreement that this is the method to be used; or
- where it is shown that the original price was calculated using a price earnings ratio; or
- if the valuation experts are agreed that such a basis is the proper basis for assessment.
Tactics
So, what can the Purchaser do to try to ensure a multiplier will be applied to damages?
- Clause in the agreement
- Recital
- Correspondence
- Evidence
- Clause in the agreement
A Seller will obviously be keen to try to avoid paying multiple damages. Therefore, a Purchaser should aim to ensure that the acquisition agreement contains a clause setting out how any subsequent adjustment in price should be calculated. This clause should be drafted to state that at the option of the Purchaser a multiplier can be used. The courts have held that where such a clause has been inserted in the agreement it is likely to be used to calculate damages.
Recital
What if the Seller refuses to allow such a clause to be inserted into the acquisition agreement?
If this is the case, the Seller may agree to the insertion of a recital at the beginning of the agreement. This will not be as binding as a clause in the agreement, but is clear evidence of the parties’ intentions.
Correspondence
Similarly, if the Seller will not agree to a clause or a recital, then any correspondence showing how the purchase price was calculated is an indication of the parties’ intentions. In particular, the basis of pricing should be set out in the Heads of Agreement as this will be clear evidence for future assessment.
Evidence
A Seller may refuse to recognise the fact that the Purchaser calculated the price on this basis. However, if it can be established that it is general practice to value companies of this type by the use of a multiplier, then the valuation expert will take this into account when deciding whether or not to apply a multiplier. Therefore, a Purchaser should gather any evidence to show this.
However, beware. Do not presume if this situation were to arise that the decision will be to your advantage. It may well be that the experts decide that the multiplier on which to multiply the damages is lower than that used initially to calculate the price to be paid.
Key point
The key is to aim to include a clause in the acquisition agreement, so ensuring that it would be clear to a court, in the event of disagreement between the parties, that this would be the appropriate method to use to calculate damages.
For further information please contact Marianthe Brotherton, 7 Devonshire Square, Cutlers Gardens, London EC2M 4YH, Tel: +44 20 7655 1200.
This article was first published in the Autumn 1999 issue of Hammond Suddards' Corporate Finance Newsletter.
The information and opinions contained in this article are provided by Hammond Suddards. They should not be applied to any particular set of facts without appropriate legal or other professional advice.
