COVID-19 and breach of warranty in acquisitions: does force majeure provide an escape for seller?

Time will tell if, and if so to what extent, the COVID-19 crisis will have repercussions in takeover country. However, previous (global) crises do not bode well: in times of crisis, certain takeovers unfortunately often turn out differently than previously hoped. If there is a breach of warranty, the buyer will want to sue the seller for damages. Can a seller successfully defend himself by claiming force majeure? And what about breaking off negotiations on a proposed acquisition as a result of the COVID-19 crisis?

Corona, warranties and force majeure

A concrete example. Suppose, in November 2019, the transfer of a construction market has taken place. This is a construction market that, through a franchise formula, operates businesses throughout Europe. In the purchase agreement, the seller has guaranteed to the buyer that the debtors of the transferred business (read: mainly franchisees) are in full force and that the bad debt provision is adequate.

Shortly after the acquisition , COVID-19 infections were detected in the countries in which the company operates, after which several national governments took action. Although DIY stores operating in European countries with (intelligent) lock down continue to do well, this is not at all the case in other European countries - such as France. As a result of the measures in force in those countries, sales are lagging behind and so are franchise payments from franchisees to the franchisor, resulting in more accounts receivable remaining unpaid after the acquisition than included in the bad debt provision. The buyer did not take it lying down and tried to pass on its losses to the seller via the balance sheet guarantee (a claim for (partial) dissolution and annulment was contractually excluded). The seller tries to ignore the liability by claiming force majeure.

With a warranty, seller takes on risk

Who bears the damage? Although the premise is that the breach of a warranted obligation (the warranty) must be imputable to the debtor(seller) in order to create liability for damages, and force majeure removes precisely the element of "imputation," in this case the seller must take into account that the buyer can successfully sue him. In fact, there are several courts that have ruled in similar cases that a breach of warranty "by virtue of legal act" must remain the seller's responsibility. The idea behind this is that a warranty generally aims to limit the very factors that constitute force majeure, and therefore prevent attribution. In other words, by means of a warranty, a seller extends his liability by assuming certain facts or circumstances for his risk regardless of whether they are due to his fault.

Ongoing acquisitions of hardware stores: breaking off negotiations

And the currently ongoing acquisitions? A current problem in takeover land is that one of the two parties no longer sees the proposed takeover as a result of the COVID-19 crisis. In that case, may negotiations be broken off without further ado? The short answer is: no. The basic principle is that each of the negotiating parties, who are obliged to have their conduct determined in part by each other's legitimate interests, is free to break off negotiations, unless this would be unacceptable on the grounds of the other party's legitimate expectation that the agreement would come about or in connection with the other circumstances of the case. In other words: in principle, negotiations may be broken off unless.... The latter is more likely if the parties had reached agreement on the essentials of the purchase agreement (think: purchase price and which shares are being sold).

What is the consequence of unauthorized interruption of negotiations? Roughly speaking, there are two flavors: (a) compensation is due or (b) there is an obligation to continue negotiating in order to reach a final agreement. Incidentally, for the sake of legal certainty, parties would do well to agree at the outset until what point they are free to leave the negotiating table and what the (financial) consequences are if they do so too late. In that case, parties usually include a break-fee (often designed as a penalty). Experience shows that this is an effective incentive for parties not to simply break off negotiations. Such clauses are, also in this COVID-19 crisis, in principle simply enforceable.

W&I insurance

In short: (especially) in times of crisis, it is important that buyer and seller - also in acquisitions of DIY stores - pay sufficient attention to the warranties and under what circumstances and until what moment they can freely leave the negotiating table. Incidentally, so-called "W&I insurance" (short for: Warranty & Indemnity insurance) can offer a solution in acquisitions where the seller does not dare to issue a comprehensive warranty package. W&I insurance provides coverage for damages (and costs) related to breach of warranties. The purpose is to transfer certain risks arising from warranties to an insurer.