The effect of 'best knowledge guarantees'

Some warranties that must be given when selling shares in a company cannot be given other than "to the best of the seller's knowledge. Take, for example, that there are no parties in the market claiming intellectual property rights of a company. A seller cannot say with certainty whether there is not someone who believes he has a particular trademark right, say an older trade name, if that party has never come forward to the company. It does not sound unreasonable then to soften the warranty to a warranty to the effect that the seller warrants only to the best of his knowledge that there is no one who believes he has such a claim.

For a buyer, however, this is not a strong warranty because, should he wish to claim such a warranty obligation, he must prove that the seller did know about the claim. But what if the buyer can also put the breach under another, more general warranty (such as a balance sheet warranty)? Can the buyer then simply choose between the general warranty (where the buyer does not have to prove knowledge of the seller) and the specific "best knowledge warranty"?

Relationship between specific and general guarantees

A recent Amsterdam court ruling shows that a buyer cannot simply fall back on a general warranty if they fail to prove science to the seller. What was the case? The case involved a company engaged in ICT services. This involved the use of Microsoft software licenses. It later turned out that the company had underdeclared numbers of licenses to Microsoft for years, and thus had underpaid fees. The buyer therefore held the seller liable for damages suffered as a result of breach of warranties.

Evidence problem

Now the issue in this case was that the seller had issued a specific warranty with respect to licenses in addition to various general warranties. However, the problem for the buyer was that the warranty with respect to licenses was limited to a "best knowledge warranty," whereas the general warranties (such as with respect to due diligence information and financial statements) did not contain that limitation. Buyer thus faced the challenge of proving that seller knew of the problems with the licenses. Buyer did not have to prove that knowledge in the case of the warranties regarding due diligence information and the financial statements. So the court had to answer the question of whether buyer could get around the proof problem by relying on the general warranties rather than the specific warranties about the licenses.

Judgment court

The court ruled (in brief) that the parties had made a specific arrangement for the course of events regarding the licenses and that therefore the buyer could not simply fall back on a balance sheet or information guarantee because in that case it would have been sufficient for the buyer to prove that the financial statements were inaccurate or misleading because the cost of licenses was too low and no provision had been wrongly included. Because the court held that buyer could not rely on the balance sheet guarantee but only on the specific guarantee for licenses, it does not seem to end well for buyer. However, the court is remarkably lenient on the buyer because the court is satisfied with the fact that the seller, as a former director under the articles of association, must have known about the too low license fees or should have made inquiries at the time. So the seller is still liable for the breach of warranty. It could have been different, because it seems that the court took the liberty not to look at what the seller (demonstrably) knew, but what he should have known. And that, in my view, is substantially different from what the parties had written down.

Multiplier

The court's decisions so far concern an interlocutory judgment. Going forward, the court has yet to decide whether a multiplier should be applied when calculating damages. The buyer (obviously) thinks so because the purchase price at the time was based on EBITDA with application of a factor or multiplier. Moreover, if the buyer faces years of higher licensing costs than budgeted, it is not surprising that the buyer would want to apply a multiplier. The seller, who naturally would like to avoid a multiplier because it will increase the damages many times over, believes that the application of a multiplier has not been agreed upon. Application of a multiplier can be avoided by stipulating that damages will be compensated "on a euro-for-euro basis," but it is not clear from the interlocutory judgment whether this is the case. The final judgment should reveal this. Reason enough to follow this case, as there is relatively little case law on the matter.