Food for thought – no finding of breach in W&I insurance claim

June saw the second-ever reported judgment in a claim under a Warranty & Indemnity (W&I) insurance policy handed down by the English Courts: Finsbury Foods Plc v Axis Corporate Capital Ltd & Ors [2023] EWHC 1559 (Comm) (the first being Ageas (UK) Ltd v Kwik-Fit (GB) Ltd [2014] EWHC 2178 (QB)).

Given the lack of judgments in this area, it is disappointing to see the insured failing to recover under the policy. However, there appear to have been various particular issues at play here:

A claim under a W&I policy will only succeed where the insured can establish a breach of the warranties covered by the policy. In this case the fundamental problem for the insured was that it could not establish that the warranties, as properly construed, had been breached.
The standard for a knowledge exclusion in a W&I policy is usually (as in this case) a high one requiring actual knowledge. However, in this case this was accepted to include “wilful blindness” and this was not a high hurdle given the relativity simple nature of the underlying facts and a number of contemporaneous emails and presentations establishing that relevant individuals were aware of these facts. In addition, much of the claimants’ witness evidence was not considered helpful by the court.
On causation and valuation, the underlying facts were again unusual in that the target was a family-owned business where (as the court found) the seller was only willing to sell at the price agreed at the outset. It was also unusual to see the court reject a submission that the business should be valued on the basis of EBITDA multiples, but again this appears to have been because the parties to the transaction had used a sales-based value at the transaction stage.

BACKGROUND

The case arose from Finsbury’s acquisition of a gluten-free bakery called Ultrapharm, a family business, for £20 million in 2018. Finsbury brought a claim for just over £3 million under a W&I policy issued in connection with the acquisition, alleging that Ultrapharm breached warranties in the SPA and that these breaches were covered by the terms of the policy.

The alleged breaches related to a trading conditions warranty and price reduction warranty that, since the Accounts Date (31 December 2017):

“there has been no material adverse change in the trading position of any of the Group Companies or their financial position, prospects or turnover and no Group Company has had its business, profitability or prospects adversely affected by the loss of any customer representing more than 20% of the total sales of the Group Companies…”
“no Group Company has offered or agreed to offer ongoing price reductions or discounts or allowances on sales of goods relating to its business or any such reductions, discounts or allowances that would result in an aggregate reduction in turnover of more than £100,000 or would otherwise be reasonably expected to materially effect [sic] the relevant Group Company’s profitability”

Finsbury alleged that these warranties were breached as a result of a recipe change agreed with, and price reductions offered to, Ultrapharm’s chief customer M&S.

The warranties were subject to a “Knowledge Exception” which provided that there would be no liability where Finsbury had “actual knowledge of the circumstances of” the relevant warranty claim and was “actually aware that such circumstances would be reasonably likely to give rise to” a warranty claim.

The W&I policy also excluded liability where individuals in Finsbury’s deal team had “Actual Knowledge” of a breach, with Actual Knowledge defined as “actual personal knowledge” which did not include “constructive or imputed knowledge”.

DECISION

The High Court dismissed Finsbury’s claims.

Breach

To determine the exact meaning of the warranties in question, the court applied (as one might expect) the leading Supreme Court decisions on contractual construction, Rainy Sky v Kookmin, Arnold v Britton and Wood v Capita (see for example this blog post). Applying the relevant principles:

The trading conditions warranty was found to comprise (a) a warranty that there had been no material adverse change (MAC) in Ultrapharm’s trading position and (separately) (b) a warranty that there had been no loss of a customer representing more than 20% of total sales. The court rejected insurers’ argument that a MAC required a reduction in turnover of at least 20%: the 20% threshold specified for the second warranty (relating to loss of a customer) could not be read across to the first warranty. However, to be a sufficiently significant or substantial change to qualify as a MAC, the change must exceed 10% of group sales.
The price reduction warranty was found to relate to price reductions offered after the Accounts Date, rejecting Finsbury’s argument that the warranty applied to price reductions effected after that date, even if they were agreed before it. That construction gave effect to the ordinary and natural meaning of the words.

On the facts, therefore, there was no breach of either warranty. The recipe change was agreed and took effect before the Accounts Date, was not in the nature of a MAC (as recipe changes were part of the ordinary course of a bakery business), and did not hit the 10% threshold, so it did not breach the trading conditions warranty. The price reduction was offered prior to the Accounts Date, so did not breach the price reduction warranty.

Actual knowledge exclusion

Notwithstanding the above, the court also found that any breach (had it been established) would have been excluded under the W&I policy on account of Finsbury’s deal team’s Actual Knowledge of the breach.

The court found that the relevant individual at Finsbury was told of the price reductions and knew that they would reduce revenues in absolute terms and would reduce the margin of the relevant products, and so he had actual knowledge of the circumstances of the warranty claim. He was not expressly aware that these circumstances were likely to give rise to a warranty claim (as per the Knowledge Exception) or amounted to a breach (as per the Knowledge Exclusion in the W&I policy), since he did not give these questions any particular thought at the time. But if he had done so he would, or at least should, have reached those conclusions.

As noted above, the Actual Knowledge exclusion was not triggered by constructive or imputed knowledge, but Finbury’s conceded that it included “Nelsonian knowledge”, or wilful blindness. The court regarded this concession as “realistic” and concluded that, in light of it, the relevant individual had sufficient information for the Knowledge Exception to apply.

Causation and valuation

Notwithstanding the above conclusions, the court went on to consider the parties’ submissions in relation to causation and valuation (assuming that a covered breach of warranty had been established):

First the court looked at what would have happened from a causation perspective. It found that Finsbury would not have been entitled to damages for any breach since it would in any event have purchased the business for £20 million (the price originally calculated as 1x annual sales). The deal was important to Finsbury and that was the price that Ultrapharm demanded. Ultrapharm was not at any stage enthusiastic about the sale and there was no basis for it to accept less. The court found that Finsbury would have done all it could to keep Ultrapharm interested, and would not have walked away. This was supported by the fact that on the transaction itself the offer price of £20 million had been maintained even in the face of a reduced EBITDA.
Finally the court briefly considered valuation. Here the court rejected both parties’ experts’ assessment on the basis of EBITDA multiples. Instead the court favoured valuing damages on the basis of the reduction in the annual value of sales (being £300,000) since this was the basis on which the purchase price had initially be set.