Representations and Warranties – Contractual and Statutory Claims

This article is part of our Disputes in M&A: 5 key trends for 2022 and beyond series: a collaboration between our market leading Corporate and Dispute Resolution teams.

Representations and Warranties

A detailed list of representations and warranties is generally incorporated into a sale and purchase agreement to solidify in writing the representations made by the seller and relied on by the buyer in entering into a sale transaction. If a warranty is breached in the sale agreement, a buyer’s recourse often lies in a conventional claim for contractual damages. However, buyers have increasingly sought statutory relief under the Competition and Consumer Act 2010 (Cth) (CCA) to broaden and bolster claims against sellers where breaches of representations and warranties are alleged to be misleading and deceptive.

This article explores how breaches of representations and warranties may give rise to causes of action not just in contract, but under statutory mechanisms in the CCA.

Breach of Contract

Breach of contractual warranty claims are common. A successful claim for breach of contract requires the plaintiff to prove:

1. the defendant breached the contract;
2. the plaintiff has suffered a loss;
3. the breach has caused the plaintiff’s loss;
4. the loss is not too remote; and
5. the plaintiff has at all times mitigated its loss.

In the context of a sale agreement, establishing that a contractual warranty has been breached is relatively straightforward. This is because the accuracy of the warranty (and therefore, the place in time when it will be analysed as either true or false) is usually determined as at the date of the contract and/or on completion (if there is a gap between signing and completion).¹ For example, if the seller warrants that it owns the intellectual property required to operate the business, but it does not, it would not be overly onerous for the buyer to establish the seller’s breach. However, establishing breach of contract is only the first (and arguably the least problematic) of many issues a plaintiff must traverse.

Contractual damages are compensatory in nature. Therefore, the starting point in assessing the plaintiff’s loss for the defendant’s breach of warranties in a sale agreement is usually the diminution in value measure, being the difference between the value of the shares (assuming the warranty to be true) and the actual market value of the shares (taking into account that the warranty is false).²

The difficulty that this provides for plaintiffs (from an evidentiary perspective) is that this rule requires that the breach has actually (and to a considerable extent) reduced the value of the business and the underlying shares acquired. If the breach of the warranty does not reduce the value of business, the compensation available to the buyer may be marginal. Worse still, if there is no reduction in value (or loss cannot be calculated), the buyer may only receive nominal damages.³

Even if a claim for breach of warranty can be established (and a loss suffered is measurable and significant) more often than not, sellers will reduce the scope of their liability by building into the sale agreement clauses that:

• exclude liability for any representations not otherwise expressly set out in the sale agreement;
   
• reduce the scope of the warranties given;
   
• include an entire agreement and or non-inducement clause; and
   
• place various limitations and exclusions on the buyer’s ability to recover damages for a breach of warranties and representations.

We often see that plaintiff’s rights to press a claim for contractual damages are fettered where the sale agreement includes a clause that extinguishes (or limits) contractual liability for breach of warranty.⁴ This raises two questions: firstly (for the buyer) under what circumstances does a seller’s breach of warranty in a sale agreement constitute misleading and deceptive conduct and thus enliven additional statutory liability under the CCA; and secondly (for the seller) when will recourse for the buyer in such circumstances be limited to the four corners of the contract?

When representations and warranties amount to misleading and deceptive conduct

It is during the process of pre-contractual negotiations and the drafting of contractual warranties that sellers must exercise caution; a long line of authorities suggest that the incorporation of representations within a contract as warranties does not disentitle the buyer, in the event of breach, from pursuing statutory remedies against the seller for misleading and deceptive conduct.⁵ This is affirmed by the “no exclusion principle” which disentitles parties from ‘contracting out’ of liability under the CCA.⁶

Section 18 of the Australian Consumer Law provides that a corporation must not in trade or commerce, engage in conduct that is misleading or deceptive or is likely to mislead or deceive.

Section 18 of the Australian Consumer Law contains the following elements:

1. a person (or corporation);
2. in trade or commerce;
3. engaged in conduct;
4. which was misleading or deceptive or likely to mislead or deceive;⁷

and that:

5. because of the conduct;
6. a person (or corporation) suffers loss or damage.⁸

A corporation engaged in negotiations with another party for the sale of its business will be engaging in “trade or commerce”.⁹

Assessing conduct of parties in commercial transactions

‘Engaging in conduct’ is defined broadly and context specific. It may be written communication, oral conversations (such as pre-contractual representations about the financial affairs of the business and ownership of its assets), gestures or even silence where there was a reasonable expectation of disclosure—the cases of Fraser v NRMA Holdings Ltd,¹⁰ and more recently Miller & Associates Insurance Broking Pty Ltd v BMW Aust Finance Ltd,¹¹ are illustrative of where non-disclosure of material facts in a prospectus was found to be misleading and deceptive.

Whether the conduct engaged in is misleading or deceptive will be determined objectively.¹² The conduct (of the seller) may be misleading if it has a tendency to lead a person of its kind (the buyer) into error.¹³ Further, agents of the company who act on behalf of the seller and engage in misleading or deceptive conduct may, by way of agency, be found to be personally liable.¹⁴

Key trends and distinctions

Dealmakers should note the following trends from recent authorities in misleading and deceptive conduct cases and further note the distinctions drawn from contractual claims:

• Pre-contractual representations are material and may be misleading or deceptive

Notwithstanding warranties expressly provided in contract, pre-contractual representations via oral and written communications can in and of themselves be found to be misleading and deceptive and carry with them a standalone right of remedy.¹⁵

In Re Stav Investments Pty Ltd (ATF The Stav Investment Family Trust) v Taylor (2022) (Re Stav Investments),¹⁶ Yatango Mobile (the seller) represented (to the buyer) that the intellectual property used by Yatango Mobile in relation to the operation of its business was owned by, licensed to or controlled by Yatango Mobile (the IP Representation). The IP Representation was false, was relied on by the buyer to enter into the transaction and was determined by the court to be conduct which was misleading and deceptive under the Australian Consumer Law (NSW) through operation of section 28(1)(b) of the Fair Trading Act 1987 (NSW). As all state jurisdictions have mirroring provisions,¹⁷ dealmakers across Australia would be wise to note the findings of this case.

• Contractual limitation clauses cannot shield the defendant from statutory liability

Nearly all sale agreements include provisions seeking to limit the seller’s liability for breaches of warranty or other provisions of the sale agreement. However, parties cannot contract out of liability arising under the ACL, thus parties seeking to rely on contractual limitations of liability may find that such limitations will not apply to limit their liability in the event of a claim for misleading and deceptive conduct. As remarked by Elliott J in Cargill Australia v Viterra Malt and Ors¹⁸ at 5330:

“Naturally, if the true counterfactual was that no transaction would ever have taken place [as a result of the misleading and deceptive conduct] then, generally speaking, it would be inappropriate for the terms of a contract that would never have been entered into to determine the rights of the parties”

Judgments by trial judges in the NSW Supreme Court have held that parties to a contract are able to set limits on their liability for misleading or deceptive conduct under section 52 of the Trade Practices Act 1974 (now section 18 of the Australian Consumer Law).

Justices McDougall and Sackar have held that limitation of liability clauses can limit:

1. the amount of the parties’ damages; and/or
2. the time within which a claim can be made (effectively bringing forward the limitations period for the claim),

for misleading or deceptive conduct.

However, in the 2018 Victorian case of Brighton Australia Pty Ltd v Multiplex Constructions Pty Ltd [2018] VSC 246 Justice Riordan held that limiting the period in which parties can claim for misleading or deceptive conduct is contrary to the public policy of the ACL. In his decision, he stated:

“It is not consistent with the public purpose of the ACL to leave claimants uncertain about whether courts, on a case by case basis, will determine contracted time limits to be so unreasonable as to be unenforceable”

To date, appellate courts have not had to address the specific issue of whether a limitation of liability clause should be read down or declared void.

• Silence can be misleading and deceptive

A seller may engage in misleading and deceptive conduct by way of “silence” where there is a reasonable expectation of disclosure to the buyer.¹⁹ In the IP Representation in Re Stav Investments, the seller had a distinct (and ongoing) obligation to disclose to the buyer (after making the false representation) that it did not in fact own the intellectual property in relation to the operation of the business. As Ward CJ remarked in the case at 535:

“[the] significance of silence always falls to be considered in the context in which it occurs”.

On this basis, it was found that the seller’s ongoing failure (the silence) to disclose the true position of its ownership of the intellectual property was misleading and deceptive.

• The factual matrix is critical and differs significantly between contractual and statutory claims

In misleading and deceptive conduct claims, courts will not consider the parties conduct in silo, opting to analyse the behaviour of parties and the context of the transaction liberally; the entire factual matrix of the matter will be critical.

In Re Stav Investments, Ward CJ stated at [532]:

“I consider that the combination of the representations made in the oral conversations and the email communications together with the final warranties in the term sheets as executed did amount to representations which have been shown to be misleading or deceptive for the reasons set out when considering the contractual warranties”

(emphasis added)

Dealmakers will note a stark contrast between the approach adopted here and that in breach of contract claims. In breach of contract claims, the parol evidence rule (which states that extrinsic evidence cannot be tendered into evidence to aid the interpretation of the contract if it contradicts or varies the contract’s existing terms) will effectively restrict the buyer from relying on precontractual conduct of the seller. Although the parol evidence rule rightly serves to ensure certainty of contract, it often comes to conflict with the reality that conduct outside the four corners of contract forms an integral part of any transaction.

• Warranties as to future states of affairs can be misleading and deceptive

Sellers must be particularly cautious in making representations or warranties as to the business’ future state of affairs. In a claim for misleading and deceptive conduct, the plaintiff bears the legal and evidentiary onus to demonstrate that on the balance of probabilities, the conduct of the defendant was misleading or deceptive. If, however, the representation relates to a ‘future matter’, the evidential onus shifts to the defendant, requiring the defendant to establish that it had reasonable grounds in making the representation.²⁰ This is particularly relevant when a seller makes projections as to the performance of the business. As stated by Gummow JJ in Accounting Systems 2000 (Developments) Pty Ltd v CCH Australia Ltd (1993)²¹:

“… A warranty as to a forecast of performance may fall within the category of, or involve the making of, a statement as to a future matter.  Such a statement can be characterised as misleading or deceptive or likely to mislead or deceive according to whether there were reasonable grounds for making it or whether any other implied representations which it conveyed were true …”

• Remedies – the “no transaction case”

Whereas damages for breach of contract serve to place the plaintiff in the position had the contract been performed (a compensatory mechanism), damages for misleading and deceptive conduct serve to place the plaintiff in the position had the misleading and deceptive conduct not occurred (a protective mechanism). Herein lies an important distinction: whereas the relief for breach of contractual warranties may be an award of monetary damages specific to the warranty in breach, if the defendant has induced the plaintiff into the transaction via misleading and deceptive conduct, the relief may result in rendering the entire transaction void (a ‘no transaction case’).

In Re Stav Investments, Ward CJ at 541 stated that:

“… an award for damages in a “no transaction” case in a suit for misleading and deceptive conduct requires the court to be satisfied that, “but for” the conduct at issue, the plaintiff would not have entered into the transaction, and so would not have suffered the loss.”

The plaintiffs submitted, with which the court agreed, that certain misleading or deceptive representations were made (e.g., the IP Representation) and relied upon by the plaintiffs in entering into the share sale agreements in circumstances where, but for those representations, the investments would not have been made.²² The appropriate remedy in the circumstances was (subject to consideration of contributory negligence and proportional liability) recovery of the totality of their investment.²³

Until such time as an Australian appellate court is asked to determine the question whether contractual limitation and exclusion provisions apply to limit a buyer’s right to make a claim for misleading and deceptive conduct, sellers should continue to construct cascading limitation provisions which are reasonable in the circumstances of the contractual relationship to give them the best chance of being upheld in the event a dispute ever makes its way to court.

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