Knead to know: what lessons does the Finsbury Food judgment deliver for W&I policyholders?

English High Court rulings concerning the application of warranty and indemnity (W&I) insurance policies are rare; really rare. So whenever judgments are handed down, it is crucial for policyholders to understand their broader implications on the W&I market and utilise insights that can be gleaned from the judge’s determinations.

From a policyholder’s perspective, the Commercial Court’s decision in Finsbury Food Group Ltd v Axis Corporate Capital & Ors [2023] EWHC 1559 (Comm) provides a cautionary tale on how to realistically pursue a W&I claim and, in doing so, how the English courts will interpret a W&I policy in conjunction with a share purchase agreement (SPA).

That said, the judgment must be read in the full knowledge that: (i) the judge’s findings were driven by the facts of this particular case; (ii) his decisions on issues beyond breach were strictly obiter (i.e. those remarks do not create a binding precedent but will be viewed as persuasive guidance on the law); and (iii) the judge found that Finsbury Food’s documentary and witness evidence was deficient in many respects.

The transaction and warranty claim

• Finsbury Food is a group of food manufacturing companies and includes a baked goods division.
• Finsbury Food wanted to expand into the growing ‘gluten-free’ market and identified Ultrapharm, a specialist manufacturer of gluten-free products, as a viable target.
• In August 2018, Finsbury Food acquired Ultrapharm for £20m. Finsbury Food purchased a W&I policy for the transaction.
• Subsequently, Finsbury Food discovered that, prior to completion, Ultrapharm had renegotiated a contract with Marks & Spencer (M&S), a key customer, altering the recipe and price of certain products.
• Finsbury Food claimed under its W&I policy alleging that: (i) this renegotiation with M&S constituted a breach of the “Trading Conditions Warranty” and/or the “Price Reduction Warranty”; (ii) the Sellers did not disclose the renegotiation before completion; and (iii) the breach(es) caused Finsbury Food to overvalue Ultrapharm by c£3.2m.

There was no breach of warranty

Finsbury Food’s claim relied on two warranties in the SPA.

The Trading Conditions Warranty

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

The application of the Trading Conditions Warranty turned on the meaning of the words “material adverse change”. Finsbury Food argued that it is sufficient to demonstrate that there has been “substantial or significant” adverse change in Ultrapharm’s trading position; alternatively, the Insurers argued, by reference to the second half of the warranty, that the clause required a threshold of greater than 20% of the total sales of Ultrapharm to constitute a “material adverse change”. The judge, whilst acknowledging that there was little authority on these words in English law and stating that the warranty itself was poorly drafted, concluded that any “material adverse change” must exceed 10% of group sales. The judge did not provide any rationale for this number, it seems as if he charted a middle course between the parties’ respective positions to reach what he thought should be the materiality threshold. In the end, the renegotiated M&S contract did not meet this 10% threshold so there was no breach.

The Price Reduction Warranty

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 

The resolution of the second warranty claim was more straightforward. The judge found that whilst the price changes came into effect after the “Accounts Date” of 31 December 2017, as defined in the SPA, the price changes had already been offered and agreed before that date in October 2017. As such, the judge held that there was no breach because the warranty was concerned with prohibiting commitments made during the “warranty period” identified by the judge (i.e. the period of time between the Accounts Date (31 December 2017) and completion (31 August 2018)).

These findings disposed of Finsbury Food’s claim; nevertheless, the judge provided further comments on prior knowledge, causation and loss.

Finsbury Food knew about the price reduction

Even if a breach had been found, the judge held that the “Knowledge Exception” in the SPA and/or “Knowledge Exclusion” in the W&I policy would have applied defeating Finsbury Food’s claim.

There was some debate over the scope of both the SPA Knowledge Exception and the Policy Knowledge Exclusion.  The clauses were not ‘back-to-back’; with the former requiring that Finsbury Food had actual knowledge of the circumstances of a warranty claim and was actually aware that such circumstances would be reasonably likely to give rise to a warranty claim; and the latter requiring "actual personal knowledge of the relevant person".  The parties ultimately agreed it was the knowledge of Jas Randhawa (a business director of Finsbury Food) which was relevant to the claim.

The judge concluded that Mr Randhawa and, by extension, Finsbury Food, had been provided with “circumstances” that should have led them to conclude that the aforementioned renegotiation with M&S had been agreed before completion.  The decision turned on the written and oral evidence.  Certain key witnesses for Finsbury Food did not give evidence at the trial; and the judge found Mr Randhawa to be “untruthful” as his oral evidence was inconsistent with the documentary evidence available.  In determining that Mr Randhawa was actually aware of circumstances reasonably likely to give rise to a warranty claim, the judge said ‘wilful blindness’ amounted to actual knowledge.  On this point, the judge highlighted that even Roger Stuart KC (Finsbury Food’s Counsel) conceded that “if one is deliberately not seeing something the reality is that one is seeing it”.

The Insured would have gone ahead with the transaction for £20m in any event 

The judge noted that Finsbury Food was a motivated buyer and the Sellers were not “enthusiastic” about the sale, and would have not parted with Ultrapharm for less than £20m.  That price was “hard-coded” into the transaction.  As such, the judge concluded that, notwithstanding any knowledge of the changes to the deal with M&S, Finsbury Food would not have “walked-away” from the agreed price of £20m.  Therefore, Finsbury Food was unable to prove that it had suffered any loss.

The actual valuation of the target business trumps the retrospective hypothetical 

Whilst not relevant to his decision, the judge did comment on the valuation of Ultrapharm.  The parties’ experts had agreed that the “conventional way” to value Ultrapharm would have been to take a run-rate EBITDA multiplied by an appropriate multiple from an agreed starting point.  However, the judge concluded that this was not the method used by Finsbury Food to value Ultrapharm during the acquisition.  Finsbury Food used a “1x sales basis” to “retrospectively sense check” the agreed and “hard-coded” £20m purchase price.  As a result, Finsbury Food would not have been able to quantify any loss by applying a conventional valuation in hindsight, but would have only been able to rely on its contemporaneous “1x sales basis” valuation – resulting in damages of approximately £300,000 rather than c£3.2m as claimed.

The judge did comment on the multiple utilised to value the EBITDA by the various experts.  In considering multiples for comparative businesses, he said that “I found it difficult to decide whose comparators are more likely to be accurate”, and ultimately averaged the contemporaneous assessments of the advisors to the transaction.

Lessons learned for insured buyers 

Whilst W&I insurance has proved to be an excellent product to provide reassurance and peace-of-mind for insured buyers, this case serves as a timely reminder that W&I insurance cannot perfect a fundamentally imperfect deal.

Specifically, this case provides the following lessons for policyholders:

1. There is no set definition for “material” in English law.  What is “material” for the purposes of a warranty will be decided on a case-by-case basis and may depend on the personal perspective of a judge in any given case.  However, this uncertainty can be circumvented or mitigated by the parties agreeing, if possible, to quantify what is “material” for any given clause.  More precise drafting of the warranties in SPAs could provide greater clarity.
2.  Although the 10% materiality threshold was an entirely subjective assessment by the judge in this case, it is not difficult to imagine that insurers and policyholders may rely on this judgment to contend that 10% of group sales is material for the purpose of a warranty breach.  If 10% would be too high for any given deal, as above, it would be worth policyholders considering whether they should quantify materiality in their SPA.
3. In terms of knowledge exemptions/exclusions, it is always important to clearly define who has actual personal knowledge (and ensure the SPA and W&I policy are aligned), but what knowledge the relevant person has is equally as important.  Here the Insurers were able to successfully argue that knowledge of “circumstances” was sufficient, even if that falls short of knowledge of the actual fact itself.  If possible, tighter drafting of any exemption and exclusion would redress the balance.
4. In determining the application of an exclusion for actual knowledge, credibility of oral evidence of the relevant individuals is assessed with reference to consistency with available documentary evidence.
5. Finally, the motivations of the transaction parties and contemporaneous valuations of the target cannot be ignored.  In this case, Finsbury Food tried and failed to retrospectively argue that it would have reduced its valuation of Ultrapharm when the evidence was not there to support such a claim.  So, Finsbury Food could not sustain its claim for damages.  Policyholders need to consider how their valuations of a target are conducted and documented, because that contemporaneous record, including the multiples used, will have a material impact on any future claim.

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