Breach of contract claims frequently arise after acquisitions, particularly where warranties or representations prove inaccurate.
When a buyer discovers issues with a company it has acquired, the financial consequences can be significant. These situations often give rise to multiple potential claims, and the quantification of loss becomes central to achieving the correct remedy. This article provides an overview of how forensic accountants approach the assessment of loss across breach of warranty and misrepresentation claims, and why choosing the correct route matters.
What do warranties and representations mean in a transaction?
During an acquisition, sellers provide warranties. These are contractual promises about key aspects of the business, for example that financial statements comply with applicable law, have been prepared consistently, reflect a true and fair view and do not omit material information.
Alongside warranties, sellers also make representations during negotiations. These may relate to business performance, risks, liabilities, or other matters the buyer relies on when deciding to proceed.
Both warranties and representations anchor the basis on which value is assessed. When they prove inaccurate, the impact on quantum can be material.
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What happens when a warranty is breached?
If a warranty turns out to be untrue, the buyer is entitled to damages that place it in the position it would have been in if the warranty had been accurate. The standard approach is to quantify loss as:
Value as warranted minus value in fact.
A common error is assuming the price paid necessarily equals the value as warranted. This is not always correct. A buyer may have struck either a good bargain or a bad bargain relative to the true warranted value. Automatically equating price with value can distort the quantum by removing the benefit of a good bargain or compensating the buyer for overpaying in a way unrelated to the breach.
For example, if the value as warranted is £2m and the value in fact is £1.5m, the true loss is £0.5m. If the price paid is automatically used instead of the actual warranted value, the calculated loss will vary depending on what the buyer paid, resulting in outcomes that do not align with the underlying valuation reality.
How does misrepresentation affect the available remedies?
Misrepresentation introduces a different set of outcomes, because the legal route determines the measure of damages.
Innocent misrepresentation allows rescission where possible, or damages in lieu for the difference between the price paid for the shares and their value had the representation been true.
Negligent misrepresentation also allows rescission or damages reflecting the reliance loss.
Fraudulent misrepresentation gives rise to rescission and damages for all losses flowing directly from the fraud, even if those losses were not foreseeable. These losses may include wasted expenditure and lost business opportunities that result directly from the deceit. The buyer must still act reasonably to mitigate its loss after discovery of the fraud.
The measure of loss under misrepresentation is therefore often broader than under a warranty claim.
How should buyers decide between warranty claims and misrepresentation claims?
The legal route chosen has a direct impact on quantum.
A warranty claim focuses on enforcing the promise made by the seller. It aims to preserve the bargain and is generally more favourable when the buyer secured a good deal and the warranted value can be established independently of the price paid.
A fraud claim seeks to unwind the impact of deception. It opens the door to a wider set of recoverable losses and allows the buyer to reverse a bad bargain entirely through rescission.
The financial implications can differ significantly. A forensic accountant can help clarify which route aligns most closely with the true economic impact of the issue.
Why involve a forensic accountant?
Post-transaction disputes often involve complex valuation questions. A forensic accountant can assist by:
- Determining the value as warranted
- Assessing the true value in fact
- Reviewing the pricing mechanism and identifying how knowledge of the true position would have altered the negotiated price
- Quantifying damages under different legal routes
- Identifying practical factors that influence valuation in the specific context
Because the correct approach is highly fact dependent, early expert involvement ensures that the approach to quantum aligns with both the legal strategy and the available evidence.
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Key takeaways
- The choice between breach of warranty and misrepresentation has material consequences for damages.
- Mischaracterising the price paid as the value as warranted can distort quantum.
- Fraud claims allow for a broader category of recoverable losses.
- Rescission will remove the benefit of a good bargain or the burden of a bad bargain.
- Expert valuation input ensures losses are quantified accurately and consistently with the underlying facts.
Frequently Asked Questions
- Why is the price paid not always a reliable indicator of value as warranted?
Because buyers can overpay or underpay relative to the true warranted value. Using the price paid as a proxy can mask whether the buyer made a good or bad bargain, which can distort the quantum calculation. - When is rescission realistically available in misrepresentation cases?
Rescission is available where it is still possible to restore both parties to their pre-contract positions. It may not be possible if time has passed, the business has changed materially, or the contract has been affirmed. - How do damages differ between negligence and fraud in misrepresentation?
Negligent misrepresentation generally limits damages to foreseeable losses based on reliance. Fraudulent misrepresentation allows recovery of all direct losses caused by the fraud, even if they were not foreseeable. - What factors influence the value in fact assessment?
These include the true financial performance of the business, undisclosed liabilities, corrected accounting issues, changes in prospects and any information that would have affected the buyer’s valuation at the time of the transaction. - At what stage should parties bring in a forensic accountant?
Ideally as soon as concerns arise. Early involvement allows for proper preservation of evidence, a clear understanding of potential quantum and informed negotiation or litigation strategy.
Disclaimer
The information contained in this article reflects the observations and experience of the author in the field of forensic accounting and is provided for general informational purposes only. Nothing in this article should be construed as legal advice, nor should it be relied upon as a substitute for professional legal advice, which (if required) readers should seek by consulting a suitably qualified and experienced legal adviser regarding their specific circumstances. Neither the author nor Frenkels Forensics makes any representations or warranties regarding the accuracy or completeness of any discussions of legal concepts. Neither the author nor Frenkels Forensics accepts any liability for any actions taken or not taken based on the content of this article.
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