The High Court (Court) has ruled on a warranty and indemnity (W&I) insurance policy claim made by Finsbury Foods Group plc (Insured) against Axis Corporate Capital UK Ltd and Others (Insurers).
The Court determined that the Insured did not suffer any loss under the policy, despite claiming losses of £3.2 million from Insurers.
Baker Tilly’s forensic, litigation and valuation services team were instructed by DAC Beachcroft LLP (who acted for Insurers) on the quantification of losses claimed under the policy, with Partner Catherine Rawlin giving expert evidence on the matter.
In 2018, the Insured, a U.K.-based speciality baked goods manufacturer, acquired Ultrapharm Ltd, a specialty gluten-free bakery with manufacturing facilities in the U.K. and Eastern Europe, from Messrs Lewis, Lewis and Lewis.
The sales and purchase agreement (SPA) was signed, and the deal completed, on 31 August 2018, for an agreed purchase price of £20 million. On the same date, the Insured entered into the policy with Insurers, which covered specific warranties and indemnities made by the sellers under the SPA.
The Insured asserted that, in 2017, Ultrapharm agreed to price reductions and recipe changes for two product lines sold to one of its largest customers, M&S, with these changes allegedly first taking effect after the accounts date, 31 December 2017.
As a result, the Insured claimed under the policy for breach of the following summarised warranties:
- “Since [31 December 2017] … no Group Company has … agreed to offer ongoing price reductions … that would result in an aggregate reduction in turnover of more than £100,000 or would otherwise be reasonably expected to materially affect the relevant Group Company’s profitability” (“Price Reduction Warranty”).
- “Since [31 December 2017] … there has been no material adverse change in the trading position of any of the Group Companies … and no Group Company has had its business … adversely affected by the loss of any customer representing more than 20% of the total sales of the Group Companies …” (“Trading Conditions Warranty””).
In relation to the quantum matters referred to in the judgment, the Insured claimed that:
- the recipe changes caused a material adverse change, in breach of the trading conditions warranty; and
- the as warranted value was the purchase price of £20 million, (reflecting a run-rate earnings before interest, taxes, depreciation and amortization (EBITDA) figure of £2.1 million and a multiple of 9.74x); and
- the actual value of the Ultrapharm shares at the warranty date was £16.8 million (based on a multiple of EBITDA methodology).
The claim was for the shortfall between the as warranted and actual values of £3.2 million.
Quantum of loss – key areas
This matter involved a number of quantum issues which commonly arise in losses claimed under W&I policies, including:
- How to quantify a material adverse change
- The Insured’s adoption of the purchase price as the “as warranted value”, particularly in circumstances where the purchase price involved in the transaction was “fixed” or set by the sellers
- The contemporaneous support for, and relevance of, the Insured’s original valuation methodology and/or any valuation multiple involved
- All claims founded upon the recipe changes were rejected by the Court as not representing a material adverse change.
- The Court ruled that the price reductions did not breach the price reduction warranty as they were offered or agreed to be offered prior to the accounts date.
- If there was a breach of the price reduction warranty, then the Court ruled that the knowledge exception would apply.
- The Court found that the Insured would not have walked away from the deal and would have proceeded at the agreed price of £20 million in any event and, therefore, the Insured was unable to prove it had suffered any loss.
- Given that the Court concluded that the Insured’s claim failed on both liability and causation, quantum is only briefly dealt with in the judgment.
- The Court found that a material adverse change in this particular case is one that exceeds 10% of the financial position or total group sales.
- It was “entirely proper” for Ms. Rawlin to point out apparent discrepancies between the way in which Ultrapharm’s valuation was assessed at the time of the transaction (using a multiple of revenue methodology) and the way in which the claim was calculated for loss purposes (using a multiple of EBITDA approach).
- The Insured’s expert adopted an EBITDA multiplier of 9.74x compared with Ms. Rawlin’s range of 7-8x EBITDA. The Court preferred to rely on the contemporaneous assessments of the sellers’ advisors to the transaction, who used a multiple of 7x and advised that the Polish (and stronger) part of the business would be valued at 8x. Therefore, the Court considered the correct multiplier was in the range of 7x to 8x.
- Applying an average multiplier of 7.5x to the Experts’ alternative EBITDA assessments of c £2.1 million (Insured) and c £2.3 million (Insurers) produced valuations of £15.4 million and £16.9 million, which are lower than the claimed As warranted value and purchase price of £20 million.
- The Insured’s expert’s assessment of actual value for loss purposes totalled £16.8 million, which was within the above range of valuation.
- If the Court had found there to be a breach of warranty, the Court would have assessed damages using a multiple of sales approach (of 1 x sales) which was the basis on which the purchase price of £20 million was originally agreed and this would have resulted in a loss of £0.3 million.
In this judgment, the Court displayed a preference for contemporaneous valuation analysis in its evaluation of quantum, being the Insured’s multiple of revenue valuation approach and the sellers’ advisors’ range of EBITDA multiples of 7-8x. This led to the Court determining that Ultrapharm was valued between £3.1 million and £4.6 million lower than the purchase price of £20 million, illustrating how it may not always be appropriate to assume that the purchase price is reflective of market value for as warranted value purposes.