“Material adverse change” warranty: interpretation after a stale M&A deal

The High Court recently considered the interpretation of a warranty in a share purchase agreement which stated that there had been “no material adverse change” in the trading or financial position of the group companies since the accounts date. The claim ultimately failed, as the Court found the claimant would have paid the full purchase price regardless and was also unable to prove it suffered any loss.

The purpose of a no material adverse change (MAC) since the accounts date warranty is to provide a buyer with protection from circumstances which have had a material adverse effect in the period since the last accounts were issued. There is no universal definition of “material”, however, so it is considered on a case-by-case basis.

In Finsbury Food Group Plc v Axis Corporate Capital UK Ltd, Finsbury Food Group (Finsbury) brought claims under a warranty and indemnity insurance policy for breaches of the “since the accounts date” warranties amounting to approximately £3 million. Finsbury is a manufacturer of baked goods which acquired Ultrapharm Limited (Ultrapharm), a manufacturer of gluten-free baked goods, by way of a share purchase agreement which completed on 31 August 2018 (SPA). Finsbury also entered into a buy-side warranty and indemnity insurance policy (W&I Policy) to cover the risk of warranty breaches.

The SPA contained the usual contractual warranties, including the following warranties:

2.1 Since the Accounts Date [31 December 2017]:

…

2.1.2 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 or by any factor not affecting similar businesses to a like extent, other than as a result of factors which have affected businesses in the same industry, in general and so far as the Warrantor is aware, there are no circumstances which are likely to give rise to any such effects;

…

2.1.9 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;

During 2017 (prior to the completion of the SPA), Ultrapharm agreed to change the recipes for two of its products for one customer (Recipe Changes) and to lower the prices of those products for the same customer (Price Reductions). Finsbury alleged that these matters constituted a breach of warranties 2.1.2 and 2.1.9, and so bought claims under its W&I Policy. The insurers rejected the claim, so Finsbury commenced legal proceedings.

MAC meaning

The first element to be considered was the meaning of “material adverse change”. The Court held it had to be considered in light of the SPA wording and the circumstances known or assumed by the parties at the time the SPA was executed. The insurers submitted that warranty 2.1.2 was a single warranty and that the reference to 20% of total sales set the threshold for the MAC, despite it being a reference in the second half of the warranty. Finsbury, however, submitted that warranty 2.1.2 was made up of 5 separate warranties drafted in a single paragraph, and that the reference to 20% of total sales did not relate to the MAC aspect of the warranty.

The judge was of the view that the warranty was not well drafted, but more importantly that warranty 2.1.2 provides:

• a warranty that there has been no MAC in the trading position or turnover of Ultrapharm; and
• a separate warranty that there has been no loss of customer representing more than 20% of Ultrapharm’s total sales, noting that this does not cover loss of custom or business, which would fall under the first warranty.

After the consideration of a number of cases, the judge concluded that a MAC in this case had to exceed 10% of the total group sales of Ultrapharm. It is not entirely clear how the figure of 10% was reached, but the judge was of the view that 10% was a “sufficiently significant or substantial change over the relevant period of 9 months”.

Warranty claims

The judge dismissed Finsbury’s claim that the Recipe Changes constituted a MAC for three reasons. Firstly, the Recipe Changes came into effect before the Accounts Date, whereas the financial position of Ultrapharm changed after the date of the SPA. Secondly, there is no evidence to show that the Recipe Changes had a financial effect which exceeded 10% of the financial position or turnover of Ultrapharm (the MAC threshold determined by the judge). And lastly, recipe changes are part of the ordinary course of business in bakery manufacturing businesses, so the development or changes to a recipe are not unusual.

As price reductions were dealt within warranty 2.1.9, the Court was of the view that the parties had agreed to treat the Price Reductions separately by applying certain criteria to establish whether there had a been a breach of the warranty. Had warranty 2.1.9 not been included in the SPA, the claim relating to the Price Reductions could have been brought within warranty 2.1.2. The judge further noted that warranty 2.1.9 related to price reductions that Ultrapharm had “offered or agreed to offer” and “not the date upon which it actually becomes effective”. Warranty 2.1.9 therefore did not apply to the Price Reductions, as the Price Reductions had been offered and agreed to prior to the Accounts Date and so there had been no breach of warranty.

Buyer’s knowledge

When considering the above, the Court also had to take into account the knowledge of Finsbury and the drafting of certain related provisions in the SPA and W&I Policy. Under the SPA, the Knowledge Exception was drafted so that if Finsbury had actual knowledge of the circumstances and was aware that these circumstances could give rise to a warranty claim, then there could be no breach by Ultrapharm. Actual Knowledge as defined in the W&I Policy meant the actual personal knowledge of a specific person of Finsbury. It was for the underwriters to prove that Finsbury was aware of the matters it was now alleging breached the warranties. The Court held the relevant person of Finsbury had sufficient knowledge of the warranty claim matters and that he knew his knowledge was “fatal” to the claim. If either of Recipe Changes or Price Reductions had constituted a breach of warranty, the knowledge provisions would have protected Ultrapharm.

Lessons learnt from Finsbury v Axis

The decision in this case shows that there is no universal meaning of “material adverse change”. The definition will need to be construed in the context of each transaction and the courts will consider the wider commercial context to rationalise their interpretation. Using financial figures to set a threshold or clearly identifying elements that may constitute a material adverse change are a good way to set out what should be considered a “material adverse change” in a specific warranty, therefore removing the ambiguity between the parties. The judgment also further emphasises the importance of carefully drafted wording in agreements to ensure the agreed position is correctly reflected.