• The court interprets actual knowledge and mitigation clauses in a share sale agreement
• The Treasury announces a new review of secondary capital raisings by companies listed in the UK
• The FRC publishes a thematic review on the use of alternative performance measures (APMs)
• The Takeover Panel publishes its first “Panel Bulletins”, on meetings and calls with shareholders and on management buy-outs
• The Court of Appeal confirms that sellers made effective disclosure outside of a formal disclosure letter
• The FRC’s Financial Reporting Lab publishes a report on early implementation of reporting under ESEF

Court interprets knowledge and mitigation clauses in a share sale agreement

The High Court has examined whether the buyer of a company was prevented from bringing claims for breaches of several warranties by virtue of being aware of the breaches before buying the company.

It also considered whether the buyer had been under a positive contractual duty to take mitigating action after completion to reduce its loss.

What happened?

Equitix EEEF Biomass 2 Ltd v Fox [2021] EWHC 2531 (TCC) concerned the sale of the shares in a biomass company by various individuals and another company.

The terms of sale were set out in a share sale and purchase agreement (an SPA). As is usual, the SPA contained warranties given by the sellers concerning the state of the business.

The buyer brought claims against the sellers alleging that numerous warranties were untrue. The court found in each case that the relevant warranty was untrue. The key questions for the court were:

• Was the buyer aware of the breaches before it signed the SPA? If so, did the SPA prevent it from claiming?
• Did the SPA require the buyer to take action after completing the sale to reduce (or mitigate) its loss? If so, should any damages awarded to the buyer be reduced to reflect this?

The question of knowledge

The general assumption is that the law prevents a buyer from claiming for breach of warranty if the buyer knew about the matter giving rise to the breach before entering into the sale and purchase. This can be explained either as a way to prevent a buyer from taking unfair advantage of this kind of knowledge, or by the fact that the buyer must have factored the breach into the purchase price.

It is nonetheless common to include specific wording in an SPA to prevent a buyer from bringing a warranty claim if the buyer already knew of the breach. This usually takes one or both of two forms:

• A warranty or confirmation that the buyer is not aware of any warranty breaches. This is designed to set up a counterclaim by the sellers that effectively “nullifies” the warranty claim, or a so-called “estoppel” that prevents the buyer from bringing a claim in the first place.
• A limitation on the sellers’ liability stating that the buyer cannot bring a claim, and/or that the sellers are not liable for a claim, if the buyer was aware of any warranty breaches when the buyer signed the SPA. This is a simple exclusion of liability.

If the buyer is a company (as it was in this case), this often extends to the actual knowledge of other companies in the buyer’s group.

In this case, the SPA contained both provisions. The confirmation clause read as follows:

[The Buyer] confirms to the Sellers that … neither it nor any other member of the Buyer Group … is actually aware of any fact, matter, event or circumstance which constitutes a breach of Warranty as at the date of this Agreement …. For this purpose, the Buyer and the relevant members of the Buyer Group shall be deemed to have knowledge of anything of which any of [Mr] Cashin and [Dr] Archer are actually aware of [sic] at the date of this Agreement.

The limitation clause read as follows:

The Buyer shall not be entitled to bring a claim and the Sellers shall have no liability to the Buyer where the facts and circumstances giving rise to the claim are within the actual knowledge of the Buyer (which for this purpose means the actual knowledge of [Mr] Cashin and [Dr] Archer … .

Mr Cashin and Dr Archer were both directors of the buyer.

The sellers argued that these two provisions achieved different things. They agreed that the limitation clause applied only if Mr Cashin and Dr Archer were aware of the breach. This was the effect of the words “which for this purpose means”.

However, they argued that the confirmation clause was not limited to the two named directors. They said the words “deemed to have knowledge” was non-exhaustive and included not only anything Mr Cashin or Dr Archer actually knew but also anything the buyer actually knew through other means (for example, anything the buyer’s technical consultants had specifically informed them about).

This was a cogent argument. There is a presumption that, if two clauses are worded differently, the parties intended them to mean different things. Otherwise, they would have used the same language.

However, the court disagreed with the sellers’ interpretation. The judge noted that, because Mr Cashin and Dr Archer were directors of the buyer, anything they knew would automatically be attributed to the buyer. It was therefore unnecessary to repeat this in the SPA and the only reason to refer to them specifically was to limit the buyer’s actual knowledge to them.

The judge said this interpretation sat better with the limitation clause. He said there would have been an “anomalous asymmetry” if the confirmation clause had been broader than the limitation clause.

The question of mitigation

Under English law, a party to a contract cannot claim contractual damages that could have been avoided by taking reasonable steps. This is usually referred to as the “duty to mitigate”. However, strictly speaking, it is merely part of the method for calculating an award of damages, so we will use the alternative label: the “doctrine of mitigation”.

It is common to include additional specific drafting in an SPA placing an explicit contractual obligation on a buyer to “mitigate its loss” and reducing the sellers’ liability if the buyer fails to do so. The SPA in this case contained such a clause, which read as follows:

The Buyer shall (and shall procure that the [target company] shall) take all reasonable action to mitigate any loss suffered by it or the [target company] which would, could or might result in a claim … against the Sellers.

The doctrine of mitigation is rarely useful to the seller of a company or business in relation to a warranty claim. This is because the doctrine generally applies to actions a party could have taken before a breach occurs. However, a breach of warranty usually occurs when an SPA is signed, and the buyer will rarely be able, before that point, to do anything to avoid or minimise it.

In this case, the buyer claimed that the express duty to mitigate in the SPA merely “codified” the doctrine of mitigation. It therefore added nothing to the general position and had no effect on the buyer’s claims. Even if it did apply, the buyer argued, the sellers were required to bring a counterclaim for breach of the contractual duty to mitigate to make use of the clause.

The sellers argued that the express duty in the SPA had to go further than the doctrine of mitigation; it would be redundant otherwise. They said it required the buyer to take mitigating action not just before, but also after discovering the breach of warranty. They also said it required the buyer to take all reasonable action to mitigate its loss (imposing a higher bar than the doctrine of mitigation, which simply requires a buyer to take action which it would be unreasonable not to take).

The court came down in the middle. The judge agreed that the contractual clause created a positive duty on the buyer to mitigate its loss and said there was no need for the sellers to launch a counterclaim to invoke it.

However, the clause did not impose obligations that were more onerous than the doctrine of mitigation (although it could have done so, if the parties had used the right words). In particular, it did not require the buyer to take mitigating action after discovering the breach. That would have imposed far too high a standard and required the buyer effectively to remedy the sellers’ breaches using its own money.

What does this mean for me?

Both points of this case illustrate a key point. English law generally caters very well for the regulation of contractual relationships between parties. The courts have developed doctrines of awareness and mitigation over centuries to ensure fairness and justice.

Parties to a contract should think carefully before including provisions that simply mirror the position at law. It is difficult to replicate years of jurisprudence concisely in a paragraph or two and simply invites the courts to find some other, often unexpected, meaning for a contractual provision.

Both examples also show that contract parties are free to “modify” the position at law (although this is not possible in all cases). However, they must use clear wording if they intend to do this and ensure there is no ambiguity over what is intended.

And, above all, similar clauses within a contract should be consistent with each other. If they are to have differing effects, the parties should consider making this clear and spelling out how the provisions are intended to work.

Treasury launches call for evidence on secondary capital raises

The Treasury has announced a call for evidence as part of a new independent review of secondary capital raises by companies listed in the UK.

The review follows the report published by the UK Listings Review, chaired by Lord Hill, which made several recommendations in relation to the UK’s listing regime. These included establishing a working group to consider how to improve the efficiency of further capital raisings by listed companies.

The initial call for evidence invites views on seven questions, which are set out below, but also invites views generally on secondary capital raisings.

1. Can and should the overall duration and cost of the existing UK rights issue process be reduced? In what ways?
2. Should new technology be used in the process to ensure that shareholders receive relevant information in a timely fashion and are able to exercise their rights and, if so, how?
3. Are there fund-raising models in other jurisdictions that should be considered for use in the UK?
4. Has the greater transparency around short selling that was introduced after the financial crisis benefited the rights issue process and is there more that can and should be done in this area?
5. Are there any refinements that should be made to the undocumented secondary capital raising process in light of recent experiences during the Covid-19 pandemic?
6. Are there any other recommendations or points made by the Rights Issue Review Group in 2008 that should be investigated further?
7. In what other ways should the secondary capital raising process in the UK be reformed?

The review has asked for submissions by 5 p.m. (BST) on 16 November 2021.

Once the call for evidence closes, the review will hold a series of discussions with interested parties to explore the issues raised further, with a view to reporting to the Treasury in Spring 2022.

Alongside the call for evidence, the Treasury has also published the terms of reference for the review.

FRC says reporting using alternative performance measures could improve

The Financial Reporting Council (FRC) has conducted and published a review of the use of alternative performance measures (APMs) by UK-listed companies.

APMs are measures of a company’s financial performance or position that are not defined by a financial reporting framework. They are commonly linked either to profitability or to balance sheet. Common profit-based APMs include earnings before interest, tax, depreciation and amortisation (EBITDA), profit before tax (PBT), operating profit and earnings per share (EPS), as well as “adjusted” or “normalised” versions of these measures. Common asset-based APMs include net debt, net cash, capital expenditure and free cash flow.

There are no legal restrictions on the APMs a company can include in its annual report or accounts. However, as a practical guide, the European Securities and Markets Authority (ESMA) has published guidelines on APMs to assist EU companies with ensuring APMs they use are useful and transparent. The guidelines make several recommendations, including:

• defining APMs clearly and consistently over time using meaningful labels;
• explaining how APMs are calculated and reconciling them to near-equivalents in the company’s financial statements; and
• not giving APMs more prominence than statutory figures.

Although the UK has now left the EU, the ESMA guidelines remain the most recent document and best practice guidance for UK issuers when deploying APMs.

The key points arising from the FRC’s review are as follows.

• Companies generally provided good quality disclosures around their use of APMs, including reconciliation to IFRS or UK GAAP equivalents, labelling and definitions.
• However, around half of the companies in the FRC’s review gave APMs more prominence or authority than GAAP measures in some areas of reporting. The FRC expects companies to ensure that APMs do not receive greater focus than GAAP measures.
• Companies in the sample used between 13 and 23 APMs. The FRC notes that high levels of APMs could obscure relevant GAAP information and so companies should consider reducing the number of APMs they use.
• Companies adjusted for more costs than income when using profit-based APMs, resulting in more favourable adjusted results than GAAP results. The FRC encourages companies to be even-handed in the treatment of gains and losses when adjusting measures and avoid systematically presenting a more favourable view of their adjusted results than GAAP measures.
• Companies could provide more granular information and explanations for individual APMs or adjusting items. For example, some companies adjusted for the effects of multi-year restructuring programmes but did not disclose relevant information such as total expected cash costs and expected durations of the programmes. Other companies used terms such as “underlying profit’” “non-underlying items’” and “core operations” but did not explain them.

Takeover Panel publishes its first “Panel Bulletins”

The Takeover Panel has announced, via Panel Statement 2021/22, that it intends to publish “Panel Bulletins” from time to time.

The Panel already publishes “Practice Statements”, which provide informal guidance on how the Panel Executive normally interprets and applies the Takeover Code in certain circumstances.

Panel Bulletins, by contrast, will not deal with interpreting or applying the Takeover Code, but rather will remind practitioners and market participants how specific provisions operate in the light of issues of which the Panel Executive becomes aware.

To this end, the Panel has published two Panel Bulletins:

• Panel Bulletin 1 – Requirements in relation to meetings and telephone calls with shareholders and others. The reminds readers of Code Provision 20.2 and, in particular, the need to ensure equality between offeree company shareholders when holding meetings or calls and for advisors to attend to ensure no material new information or significant new opinions are provided.
• Panel Bulletin 2 – Management buy-outs or similar transactions. This reminds readers of various parts of the Code that might be relevant on an MBO and of the importance of consulting the Panel Executive at an early stage if a transaction could be regarded as an MBO or similar transaction.

Other items

• Court confirms formal disclosure was made outside of disclosure letter. In Butcher v Pike [2021] EWCA Civ 1407, The Court of Appeal has confirmed an earlier decision of the High Court that, for the purpose of deciding whether a time limit on bringing claims applied, the sellers of a company effectively disclosed a breach of warranty outside of the framework of a formal disclosure letter. The Court of Appeal agreed with the High Court judge’s reasoning. For more information on the High Court decision, see our previous Corporate Law Update. 
• FRC Lab publishes report on structured reporting under ESEF. The Financial Reporting Council’s Financial Reporting Lab has published a report on early implementation of arrangements to comply with the European Single Electronic Format (ESEF). By way of background, for financial years beginning on or after 1 January 2021, issuers with securities admitted to a regulated market must file their annual financial reports in XHTML format and (if they have adopted IFRS) include XHTML tagging for basic financial information. The Lab report examines the quality of company filings (including tagging and design) and contains some practical tips for improving design and usability.