26/05/2021 Briefing

The High Court decision had reached what seemed an unfair decision from a buyer’s perspective, finding a claim notice in relation to a breach of a tax covenant was invalid as it lacked sufficient detail despite the seller having prior knowledge of the details of the matter. As such, the buyer’s successful outcome on appeal is a welcome development.

Background

The case concerned a claim notice issued pursuant to a sale and purchase agreement (the “SPA”). The SPA contained a tax covenant which provided that the sellers would reimburse the buyer in respect of tax liabilities arising from certain pre-sale events (the “Tax Covenant”). The SPA provided that in order for the buyer to make a claim under the Tax Covenant the buyer was required to give written notice “stating in reasonable detail the matter which gives rise to such Claim …”.

The buyer issued written notice of a claim for breach of the Tax Covenant relating to an investigation by the Slovenian tax authorities into transfer pricing practices of a target company. Although it was uncontested that the buyer’s notice gave reasonable detail of the nature of the claim, the sellers submitted that the notice failed to provide the reasonable detail required of the matter which constituted the factual basis of the claim, and accordingly that the purported notice did not comply with the requirements of the SPA. The High Court found that the claim notice did not satisfy the requirements of the SPA, in that it merely notified the sellers of a tax investigation, without setting out, in sufficient detail, the subject matter of the investigation, and therefore was invalid.

Court of Appeal Decision

The Court of Appeal of England and Wales2 reversed the decision of the High Court. The Court of Appeal focused on two questions:

  • What was the ‘matter’ which gave rise to the claim?
  • Was the matter stated ‘in reasonable detail’?

The Court stated that in order for there to be a claim on the tax covenant there must be a tax liability that has arisen in consequence of an event which occurred before completion of the SPA or in respect of any income, profits or gains which were earned accrued or received before completion. ‘A matter which gives rise to’ a claim is a reference to these underlying pre-completion facts giving rise to a tax liability. This will be the factual basis for the claim under the covenant and it is the ‘matter’ of which details must be given in written notice. Here, the Court agreed with the High Court that the matter giving rise to the claim was the transfer pricing practice, rather than the tax investigation.

The Court stated that what constitutes reasonable detail depends on all the circumstances. In the present case, there were three aspects which persuaded the court that the notice did contain ‘reasonable detail’ of the matter giving rise to the claim (i.e. the transfer pricing practice):

  • The level of additional information available to the buyer regarding the tax investigation was of a generic and limited nature.
  • The additional detail was known to the sellers, or was at least assumed to be known by them (based on the prior correspondence between the parties).
  • As a result of the first two aspects, it would serve no commercial purpose to set out the further information available. The purpose of the notice is to enable the recipient to make further inquiries with a view to gathering or preserving evidence; to assess as far as possible the merits of the claim; to participate in the tax investigation to the extent desirable or possible with a view to influencing the outcome; and to take into account the nature and scope of the claim in its future business dealings, whether by way of formal reserving or a more general assessment of the potential liability. The additional detail available would not have served this purpose.

Impact

While the more reasonable approach adopted by the Court of Appeal is helpful for buyers, the decision was based on the facts and in particular, in relation to the sellers’ knowledge of the details of the matter. Care is still needed in drafting notice provisions in any contract as well as the notices themselves, as a poorly thought out notice or notice provision can put one party at a significant commercial disadvantage.

As this is a decision of a court of England and Wales it is not binding in Ireland, there remains doubt as to how an Irish court might view a similar matter. As a result, those negotiating M&A documentation (and not just the tax deed) and those making claims for breaches of tax or non-tax warranties, indemnities or tax covenants under an SPA or tax deed should take note of the following:

  • Notice provisions should seek not to create “cliff edges” where by a failure to include some detail can prevent a claim being made. This is of course, a difficult negotiation point as the other party will want certainty, finality and complete information on which to base decisions in response to a notice. The balance in each case will depend on the negotiating strength of the parties.
  • Claimants should take legal advice and spend the time needed on drafting inter-parties correspondence and notices to ensure they are drafted in the required detail to meet the obligations of the claims provisions of the SPA or tax deed. Time is often of the essence in notification procedures so these actions should be taken as soon as possible after a potential claim comes to light.
  • A claim notice should set out the relevant background to any claim, including the facts, events and circumstances relating to the subject matter of the claim and not only the matter (such as a tax investigation) which brought the claim to light. This is necessary to make clear that the matter is covered by the SPA or tax deed (i.e. is a pre-completion liability).
  • The level of detail required will depend on the facts of the case but, in general, as much detail as is possible should be included in any notice. A claimant should not rely on the counterparty’s prior knowledge of certain facts or circumstances; however, failure to include such information (where the counterparty’s prior knowledge can be proven) should not be fatal to whether a claim notice is valid or not.

If you would like to discuss this case or the matters it raises in more detail, please contact a member of our Tax or Corporate and M&A teams.

[1] [2020] EWHC 2101 (Comm)

[2] Dodika Limited v United Luck Group Holdings Ltd [2021] EWCA Civ 638 (07 May 2021)