Breach of warranty v misrepresentation

In Wemyss v Karim and another [2016] the Court of Appeal considered the distinction between a claim in contract for breach of warranty and a claim in tort for misrepresentation.

Background

Mr Wemyss (the Seller) sold a solicitor's practice to Mr Karim for a purchase price of £100,000 in accordance with a sale and purchase agreement dated 31 March 2008 (SPA) with completion on the same day.

In the course of the negotiations leading up to the agreement, the Seller told Mr Karim in an email dated 4 December 2007 that the turnover of the practice was "on course" for £640,000 during the year 2008 and that net income (i.e. profit) was "on course" for £120,000.

SPA

The SPA contained the following key provisions:

• reference to a schedule of work in progress at completion prepared in connection with the SPA. As each invoice is paid the Seller and Mr Karim agreed to deposit 'the agreed apportioned amount' on an invoice by invoice basis to the account of the Seller. The valuation of conveyancing files was subject to a specified formula
• by clause 5.2 the Seller warranted that to the best of his knowledge and belief each of the warranties in Schedule 4 to the SPA is true, accurate and not misleading
• clause 5.5 provided that, in the event of a breach of warranty by the Seller, he would pay Mr Karim the amount necessary to put him into the position he would have been in had the warranty not been breached and all resultant costs and expenses, including a reasonable amount of management time
• the warranty in paragraph 1.1 of Schedule 4 provided that "...all other information relating to the Business given by... the Seller to the Buyer... are true accurate and complete in every respect and are not misleading."

Post completion

After completion, the Seller claimed for payment of sums that he alleged were due in respect of the WIP which had accrued prior to completion but had not been paid to him as provided by the SPA.  Mr Karim disputed the claim.

Mr Karim counterclaimed for misrepresentation and breach of warranty, including on the basis that the information in the email was not true.

High Court decision

The claim

In relation to the claim by the Seller for unpaid WIP, Mr Karim accepted that £29,075 was owed to the Seller, but disputed the balance of £16,783. The judge rejected the assertion by Mr Karim that the proper interpretation of the SPA meant that the Seller was restricted to the amounts of WIP shown in the schedule prepared in connection with the SPA. Rather, the reference to an agreed apportioned amount in the SPA meant that an apportionment of the eventual bill had to take place, requiring the parties to agree a reasonable apportionment in all the circumstances when the bill had been delivered, and not as referring to payment of an amount that had already been agreed.

The judge (HH Judge Cooke) accepted a concession made by the Seller that £4,000 should be deducted from the claim and awarded the Seller £12,783 of the disputed balance.

The counterclaim

In relation to the counterclaim by Mr Karim, the judge found that the statement that turnover was "on course" for £640,000 and that profit was "on course" for £120,000 was untrue when it was made and that the Seller did not believe it to be true when it was made or, subsequently, at the date of the SPA. With access to management information available at the date of the SPA, it would have been "blindingly obvious" to the Seller that the position was over-stated and untrue. The judge therefore found that liability had been established against the Seller for both misrepresentation and breach of warranty. A more accurate figure for turnover would have been £547,000 or less and for profit would have been £92,000.

However, as no recoverable loss could be demonstrated, the judge declined to award Mr Karim any damages. The judge had no valuation evidence either of the value of the business at the date of the SPA or of the value that the business would have had if the warranted information had been true, complete and not misleading.

Court of Appeal decision

The claim

In relation to the claim, the Court of Appeal held that the judge at first instance had been wrong in his interpretation of the SPA. The correct meaning of 'agreed apportioned amount' in relation to the WIP at completion was the apportioned amount which the parties had agreed rather than an amount that they 'agreed to agree' in the future. The SPA contained no contractual machinery for resolving any future dispute. Lawyers entering into the SPA must be taken to have understood the obvious difficulties in entering into an 'agreement to agree'

The Seller put forward figures in the schedule prepared in connection with the SPA and Mr Karim accepted them. The judge at first instance had held that it was for Mr Karim to provide evidence if he disputed the Seller's figures. In the view of Lewison LJ, it was for Mr Wemyss to establish his claim.  Mr Karim was asserting a negative (i.e. that there was no justification for altering the WIP figures in the schedule).  It was unrealistic to expect proof of a negative.  The burden was on the Seller to justify any change file by file and the judge was wrong to have held that the Seller had established his claim, except to the extent that Mr Karim had admitted it.  In effect the judge had reversed the burden of proof.

The Court of Appeal reduced the amount awarded to the Seller on the claim by £12,783, being the amount of the disputed balance awarded to the Seller by the High Court.

The counterclaim

Breach of warranty v misrepresentation

In his judgment, Lewison LJ set out the underlying principles which distinguish a claim in contract from a claim in tort.  The claim was put as both a claim for breach of warranty (i.e. a claim in contract) and also as a claim for misrepresentation (i.e. a claim in tort).  The calculation of damages, however, differs depending on the basis of the claim. 

• In the case of a warranty claim, say about the quality of an asset which is sold – the measure of damages is the difference between the true value of the asset and its value with the quality as warranted
• In the case of a claim in tort – the measure of damages is the difference between the true value of the asset and the price actually paid.
• The distinction was summarised by Lord Denning in Doyle v Olby (Ironmongers) Ltd [1969]:

"On principle the distinction seems to be this: in contract, the defendant has made a promise and broken it. The object of damages is to put the plaintiff in as good a position, as far as money can do it, as if the promise had been performed. In fraud, the defendant has been guilty of a deliberate wrong by inducing the plaintiff to act to his detriment. The object of damages is to compensate the plaintiff for all the loss he has suffered, so far, again, as money can do it."

Lewison LJ summarised the distinction with this example:

Suppose that A owns a painting that he tells B was painted by a famous artist. If it had been, it would be worth £10,000. B pays £8,000 for it. It was not in fact painted by the famous artist and was only worth £100. If B can establish that what A said was a contractual warranty, then he is entitled to £10,000 - £100 = £9,900. But if he can only establish that the statement was an actionable misrepresentation, then he is entitled to £8,000 - £100 = £7,900, although if the misrepresentation was (or is treated as) fraudulent he may be entitled to consequential losses as well. Changing the facts, perhaps unrealistically, if the painting as warranted would have been worth £10,000 but is in fact worth £8,000, then on the contractual measure the buyer who paid £8,000 will recover £2,000; but on the tortious measure will recover nothing.

Another important difference between claims in contract and claims in tort is that in a case of misrepresentation the claimant must show that he relied on the representation in deciding to enter into the contract. Quoting Slade L J in Harlingdon and Leinster Enterprises Ltd v Christopher Hull Fine Art Ltd [1991]:

"If a party to a contract wishes to claim relief in respect of a misrepresentation as to a matter which did not constitute a term of the contract, his claim will fail unless he is able to show that he relied on this representation in entering into the contract; in general, however, if a party wishes to claim relief in respect of a breach of a term of the contract (whether it be a condition or warranty) he need prove no actual reliance."

However, in the case of a claim for breach of warranty the claimant need only prove that the warranty has been broken.

What the Seller said on 4 December 2007 was that the LLP was "on course" for the stated turnover and profit. Mr Karim argued that this was a continuing representation or warranty which continued to have causative effect up to the completion date. The proposition that a representation can be a continuing representation is well-established; see With v O'Flanagan [1936], which was approved by the Supreme Court in Cramaso LLP v Viscount Reidhaven's Trustees [2014].

The Court of Appeal accepted that the Seller's statement on 4 December 2007 that the LLP was "on course" for the indicated turnover and profit was a continuing representation that it remained on that course up until completion. Since the representation was untrue it was a misrepresentation; and since the judge at first instance held that the Seller did not have reasonable grounds for believing it to be true (and did not in fact believe it to be true), it was an actionable misrepresentation giving rise to a liability in tort. That liability would attract an award of damages calculated according to the tortious measure: i.e. the difference between the price paid by Mr Karim and the actual value of the business at the completion date.

Mr Karim's alternative claim for damages was for breach of warranty. The warranty in paragraph 1.1 of Schedule 4 was expressed in the present tense and did not merely warrant that the information provided was true at the time it was given. Additionally, the warranty was not merely a warranty that the information was true, it also warranted that the information was complete and not misleading. The information the Seller provided was not true at the date of completion and was also incomplete and misleading.  The Seller was therefore in breach of warranty.

Decision

The result was that Mr Karim was entitled to damages on both the tortious measure for misrepresentation and also the contractual measure for breach of warranty. Which he chose would depend on which produced the better result for him. The tortious measure is the difference between (a) the price that Mr Karim paid and (b) the true value of the business. The contractual measure is the difference between (a) the value of the business if the warranted information had complied with the warranty: i.e. it had been true, complete and not misleading and (b) its true value.

Measuring the loss

Although there was a lack of valuation evidence, it was self-evident that a person who buys a business with a warranted profit earning capacity of £120,000 suffers a substantial loss if the business in fact has a profit earning capacity of only £92,000. But how can the loss be measured? The profit earning capacity of a business is most usually reflected in its goodwill. As Swanwick J pointed out in Doyle v Olby (Ironmongers) Ltd the value of goodwill is generally arrived at by applying a multiplier to the annual profit. What was the appropriate multiplier?

The Court of Appeal calculated that the balance of the purchase price attributable to goodwill was £68,140, and this was therefore the price of the warranted profit of £120,000. Although usually the price paid for goodwill is a multiple of profit, in this case the price paid was a fraction of profit, which was 1.76.  Accordingly, damages were assessed by applying the divisor of 1.76 to the shortfall in profit of £28,000, which gave a difference in value of £15,909.  This sum, rounded down to £15,000 was awarded by the Court of Appeal as damages for the breach of warranty.

Result

The Court of Appeal also increased the award of the management time from £1,800 awarded by the High Court to £3,600, representing 60 hours of management time at £60 per hour, to reflect overhead costs. The net payment by the Seller was accordingly reduced to £15,417 from the High Court award of £45,000.