breach of warranty with decided case . chined

BREACH OF WARRANTY WITH DECIDED CASE

A breach of warranty involves a broken promise about a product made by either a manufacturer or a seller. The term also covers a failure of a statement or agreement by a seller of property which is a part of the contract of sale, when the truth of the statement is necessary to the validity of the contract. Warranties are also express or implied. An express warranty is a particular stipulation introduced into the written contract, by the agreement of the parties; an implied warranty is a guarantee imposed by law in a sale. Even though the seller may not make any explicit promises, the buyer still gets some protection.
Warranty protection is provided under the Uniform Commercial Code (UCC), which has been adopted, at least in part, by all states. On the federal level, Congress enacted the Magnuson-Moss Warranty—Federal Trade Commission Improvement Act of 1975, The federal Act has had a substantial impact on the warranty provisions of the Uniform Commercial Code. In general, it mandates certain guidelines in connection with written warranties and, where written warranties are given, invalidates attempts to disclaim implied warranties. The federal Act is aimed at written warranties and service contracts made in connection with the sale of "consumer products," requires that they they must meet federal standards in terms of disclosure and remedies provided to an aggrieved consumer.

Breach of Warranty

Warranties are certain kinds of express or implied representations of fact that the law will enforce against the warrantor. Product liability law is concerned with three types of warranties involving the product's quality or fitness for use: express warranty, implied warranty of merchantability, and implied warranty of fitness for a particular purpose. These and other warranties are codified in the Uniform Commercial Code (UCC), which every state has adopted, at least in part.

An express warranty can be created in one of three ways: through an affirmation of fact made by the vendor of the goods to the purchaser relating to the goods, which becomes part of the bargain; by way of a description of the goods, which is made part of the basis of the bargain; and through a sample or model, which is made part of the basis of the bargain (U.C.C. § 2-313).

An express warranty can be words spoken during negotiations or written into a sales contract, a sample, an earlier purchase of the same kind of product, or claims made in publicity or on tags attached to the product. An express warranty is created when a salesperson states that the product is guaranteed to be free from defects for one year from the date of the purchase.

Implied warranties are those created and imposed by law, and accompany the transfer of title to goods unless expressly and clearly limited or excluded by the contract. However, with respect to damages for personal injury, the UCC states that any such contractual limitations or exclusions are "prima facie unconscionable" and cannot be enforced (U.C.C. § 2-719 (3)).

The implied warranty of merchantability requires that the product and its container meet certain minimum standards of quality, chiefly that the product be fit for the ordinary purposes for which such goods are sold (U.C.C. § 2-314). This requirement includes a standard of reasonable safety.The implied warranty of fitness for a particular purpose imposes a similar requirement in cases in which the seller knows or has reason to know of a particular purpose for which the goods are required and in which the buyer is relying on the seller to select or furnish suitable goods. The seller then warrants that the goods are fit for that particular purpose (U.C.C. § 2-315). For example, assume that the buyer tells the seller, a computer supplier, that he needs a high-speed computer to manage inventory and payroll functions for his business. Once the seller recommends a particular computer to handle these requirements, the seller is making an implied warranty of fitness. If the computer cannot adequately process the inventory and payroll, the buyer may file suit.

The action for breach of one of these warranties has aspects of both tort and contract law. Its greatest value to the injured product user lies in the fact that liability for breach is strict. No negligence or other fault need be shown. However, in addition to the privity limitation, certain contract-related defenses have impaired the remedy's usefulness. These include the requirement that the seller receive reasonably prompt notice of the breach as a condition to his or her liability, the requirement that the buyer has relied upon the warranty, and the ability of the seller to limit or disclaim entirely the implied warranties. These defenses are most appropriate in cases in which a product's failure causes economic loss. The trend has been away from strict enforcement of these defenses in personal injury cases in which the action is closer to a tort action.

DEICIDED CASE

case 1

For example:

Alberto, a long distance runner, goes into a sporting goods store to buy running shoes. The seller, Bill, knows that Alberto is buying shoes for a long distance race and that Alberto is relying on Bill’s judgment to provide him with the shoes most appropriate for long distance running. In such a case there is an implied warranty that the shoes Bill sells Alberto will be fit for long distance running. If it turns out the shoes are not fit for long distance running, Bill has breached an implied warranty and can be held liable.

For example:

Firestone is a car tire salesman. Winston goes to Firestone to buy tires for his car. Because Firestone deals in tires, there is an implied warranty that the tires he sells to Winston are of average quality. If these tires prove unfit, Firestone can be held liable for breach of an implied warranty of merchantability.

While the UCC only applies to the sale of goods, case law has applied these warranties in cases involving the bailment or lease of personal property. However, the warranties will only be implied in contracts for goods and will not be implied in contracts for services.

case 2

EXAMPLE: Alan purchases a computer and some expensive accounting software from ABC Computer. He thoroughly explains his specialized bookkeeping needs to the salesperson and is assured that the computer and software will do the job. The computer contains a written warranty against defects in parts and labor for 90 days. The warranty statement says that all implied warranties are disclaimed. The software contains no written warranty statement. It is apparent to Alan after a couple of days' work that the software simply is not sophisticated enough to meet the bookkeeping needs he had explained to the salesperson and that the salesperson didn't know what he was talking about when he said it was "perfect for the job."
Two days later the computer has a major crash. Alan calls ABC and asks for the computer to be fixed or replaced and for his money back on the software. When ABC ignores him, Alan sues in small claims court. Alan should have no problem recovering for the price of the computer–it failed within the written warranty period. But the software raises a tougher problem. Alan is claiming a breach of an express oral warranty (the salesperson's statement that the software would meet his needs), and a breach of the implied warranty of general fitness or merchantability. To succeed on the first claim, he must prove that the salesperson did in fact assure him that the software was right for his needs, which may be difficult. Proving the second claim will be even harder, however, because Alan must somehow prove that the software falls below the reasonable standard for sophisticated small business accounting packages. ABC is likely to counter Alan's claim with evidence that the software is in wide use and is generally considered to be adequate to accomplish most accounting tasks. In short, Alan would be smart to focus on trying to prove that in making his decision to purchase the software, he relied on the salesperson's oral statements that the software would meet his specific bookkeeping needs.
How should he do this? If Alan gave the salesperson a written specification detailing his accounting needs and still has a copy, he should show it to the judge. Even better, if he has a witness who heard the salesperson's overly optimistic promises, he should ask this person to testify in court or at least write a letter stating what happened. Unfortunately, if Alan has no convincing evidence as to the salesman's statements, the small claims hearing is likely to come down to his word against the salesperson's, with the judge left to decide who appears to be telling the truth.

cases 3

two recent cases relating to breach of warranties in share purchase agreements: The Hut Group Limited v Nobahar-Cookson and another and Augean plc v Hutton and others.

The Hut Group also considers other issues, including the process for notification of warranty claims and the effect of fraud.

Background

Both cases relate to the sale and purchase of the entire issued share capital of a company. In Augean this was a waste management business. The purchase price comprised cash paid at completion, a cash retention payable later and an earn-out. One of the claims brought by the buyer related to a breach of the accounts warranties in the sale agreement.

The Hut Group related to the sale and purchase of an online sports nutrition business. The sellers sold the target for cash and also a minority shareholding in the buyer. The buyer brought a claim for breach of warranty relating to the target’s management accounts and the sellers counter-claimed for fraudulent breach of the accounting warranties given to them in relation to the minority shareholding.

Calculation of damages

The two cases show that calculation of damages for breach of warranty is likely to vary depending on whether the claimant has acquired a majority or minority shareholding (and the basis on which the parties valued the target). In both cases – where the buyers had acquired 100% of the target company – the correct method for calculating damages was held to be the difference between a multiple of EBITDA calculated as if the warranties were true (a ‘warranty true’ basis) versus a multiple of EBITDA based on the target as it actually was (a ‘warranty false’ basis). In both cases, the EBITDA on a ‘warranty false’ basis was smaller, but the multiplier remained the same. In The Hut Group it was argued that, when calculating the ‘warranty false’ value, a reduced multiplier should apply (hence enhancing the difference between ‘warranty true’ and ‘warranty false’). The court did not reject this in principle, but disallowed it on the facts, finding that a reasonable buyer and seller would not have revisited the multiple as well as the EBITDA. A reduction in the multiplier was not addressed in Augean.

In The Hut Group, the sellers’ counterclaim related to their minority (about 12%) shareholding in the buyer. Because of this, the judge decided that the correct measure of damages should be based on a discounted cash flow basis. The judge followed the established contractual principle that damages are generally to be calculated as at the point of breach, but added that damages can be forward-looking and can take into account the claimant’s expectations. The fact that, at the time of the sale, the sellers had a clear expectation that the buyer would be involved in an IPO, and that this would result in a windfall increase in the sellers’ shareholding in the buyer, was taken into account in calculating the ‘warranty true’ value. But the fact that the IPO might still happen in the future and the price of the shares might recover was not taken into account in calculating the ‘warranty false’ value.

Price adjustment mechanisms and subsequent claims

In Augean the amount and type of waste stock on site at the target gave rise to a number of allegations of breach of warranty. The disclosure letter included a statement that the cost of treating waste stock had not been included in the accounts and that it was estimated to be £25,000. The completion accounts subsequently included a provision for waste stock of just under £75,000. The buyer confirmed that the completion statement was agreed without amendment and gave a statement that ‘at today’s date there are no known matters which we believe give rise to a claim under the Warranties’. The actual cost of treating the waste stock was higher than had been estimated in either the disclosure letter or the completion accounts, so the buyer brought a claim for breach of the accounts warranty. The judge found that, at the point the completion accounts were agreed, the buyer clearly did not think that there was a material difference between the estimate given for waste stock in the disclosure letter and the provision in the completion accounts, and that this weighed evidentially against the buyer in its attempt to maintain a claim for breach of the accounts warranty. This suggests that a buyer should take great care to reserve its rights when agreeing completion accounts if it is expecting to bring a warranty claim in the future that relates to the relevant item.

Damages for one-off items

In both cases, where breach of warranty was proven, the judge calculated damages in respect of one-off items on a ‘cost-of-cure’ basis – i.e. a pound-for-pound recovery – even though the claim was for breach of warranty rather than an indemnity claim. This illustrates that, in practice, all is not necessarily lost as far as the buyer is concerned if the share purchase agreement does not provide expressly for recovery for breach of warranty on an indemnity basis, since the same pound-for-pound calculation might be applied by the court, provided it is reasonable and proportionate to do so.

Notification of warranty claims

In The Hut Group, the sale agreement provided that warranty claims must be notified within 20 days of the party ‘becoming aware of the matter’. When did awareness occur? The judge said that, to make commercial sense of the agreement, time started to run only once the buyer had enough information to realise that there was a proper basis for putting a claim forward – in this case, that point was not reached until the buyer had had initial advice from forensic accountants. Nevertheless, the case highlights the risk to the buyer of specifying such a short period for notification, as it can be difficult to review and consider a potential claim within that period.

The sellers tried to argue that the notice of claim did not meet the requirement in the sale agreement to specify the nature of the claim in reasonable detail and the amount claimed. The judge considered the notice to contain all that was practicable at that early stage by way of quantification, and commented that not much was required by way of description. Much depends on the wording of the agreement, however – in other cases, would-be claimants have been barred from bringing warranty claims because they have not meticulously complied with notification provisions.

Damages for fraud

In The Hut Group the sale agreement contained a financial cap on the buyer’s liability to the sellers but (as is standard) provided that the cap would not apply in cases of fraud. The sellers argued that the accounts warranties relating to the buyer were untrue and were based on fraud. It was accepted by both sides that the buyer’s financial controller had manipulated the buyer’s accounts, but the buyer argued that the financial controller’s fraud was not attributable to the buyer: he was not senior enough.

But the judge decided that, although the financial controller was not a director, he was involved in the deal and had personally provided information relating to the accounts warranties. The fact that he was not ‘front facing’ was irrelevant. His fraud was the buyer’s fraud and the cap did not apply.

Agreements often provide that the awareness of the parties is to be fixed by reference to the knowledge of named individuals – for example, where warranties are qualified as being given ‘so far as the seller is aware’ or the buyer affirms that it is not aware of any grounds for a future warranty claim. The case is a salutary reminder that provisions like this will not necessarily have any bearing on whether fraud can be attributed to a party (and it is doubtful whether the parties could effectively pre-ordain whose awareness is to count where fraud is in issue).

Comment

These cases are helpful as reminders of the basic principles which underpin damages for breach of warranties, and offer some useful pointers for the negotiation of M&A transactions and the avoidance of pitfalls.