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116 Cardamon Limited and MacAlister [2019]

Author: Andrew Strickland

Published: 04 May 2022

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Claimed breaches of warranties in share purchase agreement.

Flying High

Cardamon claimed for damages for breaches of warranties contained in a share purchase agreement dated 23 May 2014 (the “SPA”). That SPA related to the purchase of 100% of the shares in Motorplus Limited. a privately owned company regulated by the Financial Conduct Authority (“FCA”).

The business of Motorplus involved selling policies of insurance such as legal expenses insurance and lost key insurance which are “added-on” to policies of motor or household insurance. It also provided claims handling and first notification of loss services to underwriters.

This was a modest transaction, with consideration for the shares of some £2.4 million. This was also the ceiling for warranty claims. For this size of transaction the de minimis for warranty claims may appear surprisingly high. This was set at £500,000.

The reason for the high de minimis related to the nature of the transaction: the sellers convinced the buyer that this was a bargain purchase, so only very limited due diligence was to be undertaken and there were to be no penny-pinching warranty claims.


After Completion the buyer found that there were continuing requests for cash from the new, troublesome subsidiary. As these cash demands continued, the buyers realised that there was something seemingly amiss with the bargain purchase. Its review of the accounting evidence led the buyer to conclude that the company was insolvent at the time of purchase.

The warranties of relevance related to the financial statements for the year ended 31 August 2013 and the management accounts to April 2014 and whether or not they were fairly stated.

The buyer maintained that accounts materially mis-stated the following:

  • Provisions needed in respect of “before the event” legal expenses insurance policies;
  • A loan to an associated company which should have been written off in full rather than to the extent of 50%;
  • The accounting policy used in recognising the commissions payable to insurance brokers.

The first of the claims was the most substantial and the most well-founded. The claim in this respect was for £2,159,000, which converted a profit before tax for the year to August 2013 of £1,272,000 into a loss of £887,000. The need to write off the whole amount due from the associated company increased the loss to £1,457,000.

The birds come home to roost

One of the major issues was the accounting periods affected by the under-provisions for the legal expenses insurance claims: it was argued for the buyer that the financial statements for the year ended 31 August 2012 included a careful review of the provisions required; there was then a change of auditors and the work done in the following year was rather more cursory, and did not include a review of the claims notified after the balance sheet date. There was then a further change of auditors. The next set of financial statements included large prior year adjustments in respect of the measurement errors at August 2013.

Smoothing the Feathers?

There were two accountancy experts appointed, one a very experienced Chartered Accountant and the other a specialist forensic Accountant. The written decision recorded that they did not see eye to eye on all issues. However, “they did their best to co-operate with each other in the way experts in this Court should do.”

The material differences of opinion of the experts related to the adjustments needed to change enterprise value to equity value. In other areas their views appeared to be close.

Warranty True, Warranty False

In such cases it is established that the measure of loss is the difference between the value of the company on the basis of the warranties being true, and the alternative value on the warranties being found to be false. Both of these have to be taken as absolute positions, not ones surrounded by doubts and uncertainties.

The concept of the bargain sale came to haunt the Sellers: both experts agreed that the value of the business on the warranty true basis was rather greater than the consideration paid by Cardamon of £2.4m and was closer to £3.4m.

Valuation points

The two experts agreed on an EBITDA multiple of 3.75. The Judge preferred the view of one expert on the maintainable EBITDA of £849,000. This gave an enterprise value of some £3.2 million.

In order to convert the enterprise value into equity value it was necessary to deduct interest-bearing debt and to add on non-operating assets.

The company had required significant cash injections following the transaction and had net liabilities on a warranty false basis. The Judge preferred the evidence of one of the experts that the company needed further funding and that such funding requirement should be deducted from the enterprise value even though it was not in place at completion.

A counter argument was put forward that only short-term borrowing was required as the retention of profits over two or three years would restore the position of the balance sheet. It is perhaps unsurprising that this argument did not succeed.

An addled egg

It is a matter for some concern that the Court decided in this case that a director’s overdrawn loan account was not a non-operational asset, to be added to enterprise value in order to derive the value of the equity. One of the experts argued strongly that this was the appropriate treatment; the views of the other expert are not stated.

The Judge, for some reason, found the argument to be “specious”. The written decision states the following: “Ultimately it has seemed to me that the value of the Company is artificially inflated if something is counted as an asset which the purchaser nonetheless has to fund.”

The rest of the decision in this respect appears to be wrapped within the rather separate question of the funding need of the business. It appears that the two issues were intertwined in the mind of the Judge.

The quantum

The Judge satisfied himself that the claim exceeded the de minimis hurdle of £500,000. It also exceeded the absolute limit on claims of the consideration of £2.4m. Therefore, the claim was awarded of an amount equal to that consideration.