The High Court in Dodika Ltd v United Luck Group Holdings Ltd  EWHC 2101 (Comm) recently held that a buyer’s provision of a notice in respect of a claim under a tax covenant contained in a share sale and purchase agreement was invalid.
Whilst both the Buyer and the Sellers had been involved in a tax investigation into the Target Group following completion of the transaction, the High Court held that the purpose of a claim notice was to inform the Sellers of the facts of the claim, despite any knowledge or involvement, so that they could assess and decide their course of action.
The High Court found that the notice served on the Sellers by the Buyer for breach of a tax covenant, following the initial results of the tax investigation, did not adequately comply with the provisions of the share purchase agreement and was consequently unenforceable.
Despite being seen as a harsh learning curve for the Buyer, all parties to agreements should bear in mind that it is equally important to carefully consider and take expert advice if needed when executing transactions as well as in circumstances where there may be a potential breach of warranty, indemnity or tax covenant. It is important to carefully review limitation and notice provisions following closure of a transaction and most importantly, draft claim notices in accordance with the requirements of the relevant agreement so as not to find oneself in the same position the Buyer in this case.
In December 2016, United Luck Group Holdings Ltd (the “Buyer”) acquired Oufit7 Investments Limited, a corporate group specialising in mobile device applications (the “Target Group”). The sale was governed by a share purchase agreement between the Buyer and nearly 200 sellers which included Dodika Limited, Gedala Limited, Login Establishment, Laytonera Limited, Ninaz Limited, Romih Limited, Tarmea7 Limited, Zetta IQ Limited (together the “Sellers” and the “SPA”).
The SPA contained a tax covenant given by some, but not all, of the Sellers in favour of the Buyer, under which those Sellers promised to reimburse the Buyer for any tax liability of the Target Group arising out of or in connection with events that occurred prior to completion of the SPA (“Completion” and the “Tax Covenant”).
Under the terms of the SPA, a proportion of the purchase price was placed in escrow in case of any clams which the Buyer might have in respect of any breach of the SPA by the Sellers. In such circumstances, half of the escrow amount would be released to the Sellers two years after Completion, and the balance was to be released seven months later. Under the SPA, the Buyer could bring a claim under the Tax Covenant only if it issued written notice before the second escrow release date (the “Deadline”) “stating in reasonable detail that matter which gave rise to such Claim, the nature of such Claim and (so far as reasonably practical) the amount claimed”.
In 2018, 18 months after Completion, the Buyers commenced an investigation into the tax affairs of one of the Target Group. The Target Group corresponded with the tax authorities for a subsequent 11 months. The Buyer updated the Sellers’ representative with any material developments in respect of the investigation and the Sellers had been involved in meetings and strategy discussions in respect of the investigation.
Whilst investigations were still ongoing, pursuant to the terms of the SPA, the Buyer sent the Sellers written notice of a claim for breach of the Tax Covenant one week before the Deadline. The notice referred to the relevant provisions of the SPA and the ongoing tax investigation into the Target Group’s subsidiary. In summary, the notice set out:
- a brief chronology of events which noted that the tax authority had commenced an investigation into the Target Group’s subsidiary;
- confirmation that the Buyer was claiming the amount “equal to any Tax Liability that the Tax Authority may impose … following its investigation”; and
- confirmation that, as at the date of the notice, the tax liability was contingent and therefore the Buyer was not able to quantify the claim at that time.
- As the matter is yet to be determined, the Buyer did not intend to instruct the escrow agent to release the balance of the purchase price.
It is worth noting that Sellers were aware of the investigation and the Sellers had been involved in meetings and strategy discussions in respect of the investigation. The Buyer also kept the Sellers up to date with any material developments in respect of the investigation. Nonetheless, the Sellers issued legal proceedings against the Buyer on the grounds that the Buyer’s notice did not comply with the provisions of the SPA because (1) it failed to quantify the claim; and (2) did not provide reasonable details of the nature of the claim.
High Court ruling
The High Court held that the notice issued by the Buyer to the Sellers failed to meet the notice requirements set out in the SPA (and as mentioned above) and consequently it deemed the notice invalid on the basis that the notice failed to provide reasonable details of the factual basis of the Buyer’s claim.
Although seemingly a harsh position to take, the Court held that the fact that the Sellers were aware, and were involved in the tax investigation, did not detract from the Buyer’s obligation to comply with the notification requirements under the SPA. The brief chronology of events provided in the notice was a key factor in the High Court’s decision.
In arriving at its decision, the High Court considered a number of previous cases concerning similar notices, including the recent case of Stobart Group Ltd v Stobart & Tinkler  EWCA Civ 1376 which we covered in our March edition of the Full English covering 2019 cases.
The High Court stressed that contract terms relating to the provision of a notice in respect of a claim needed to be interpreted in its own context, taking into account the parties’ intention and the commercial purpose of the SPA provision in question. The High Court ultimately found that the following key principles could be derived from previous caselaw:
- The reason for prescribing contents of a claim notice is to ensure commercial certainty and inform the receiving party of what facts discovered during the Buyer’s investigations are relied upon in support of the breach of Tax Covenant;
- The notice must contain sufficient information to allow the recipient to make an informed assessment of the claim it is exposed to and determine, with the benefit of legal or tax advice, at least in general terms whether the facts as alleged give rise to or might give rise to liability for breach of the Tax Covenant;
- The test is what a reasonable recipient would have understood upon receiving the notice if asked the basis of the general facts under which such claim was being made.
This case acts as yet another stark warning to all buyers to comply fully with the contract terms when giving notice of a claim.
Whilst the Sellers’ involvement in the tax investigation lends itself to an understanding as to why the Buyer may have decided to not include more detail in its notice, sparing and/or not repeating all the investigation details in the claim notice was absolutely detrimental to the Buyer. However, the High Court held that the purpose of a claim notice is to inform the Sellers of the facts of the claim so that they can assess and decide their course of action despite any knowledge the Sellers may already have and the Buyer’s non-compliance with the requirement to set out reasonable detail in the notice under the SPA was paramount to its failure.
Although the High Court’s decision has been viewed by some as unfair, given the knowledge held by Seller of such investigation, the Court upheld the objective standard required in contractual interpretation. Simply put, the notice did not adhere to the notice requirements in the SPA and parties must not be tempted to disregard notice provisions on the basis that they are “boilerplate”, either during negotiations or more particularly when preparing and delivering a claim notice, and whether or not the other party has knowledge of such claim already existed.
Despite being a harsh learning curve for the Buyer, any other buyer should bear in mind that it is equally important to carefully consider and take expert advice both when executing transactions as well as in circumstances where there may be a potential breach of warranty, indemnity or tax covenant, where advice should be sought to review limitation and notice provisions following closure of a transaction and most importantly, to comment on or draft claim notices prior to any party issuing a notice to the other party.