If A buys shares from B, and B made certain warranties to A about the company which turned out to be false, A can sue B for breach of warranty. Separately, if B had made misrepresentations to A to induce A to purchase the shares, A can sue B for misrepresentation in addition to breach of contract.
This may occur for example where it was falsely warranted that the company’s profits were higher than they in fact were, or that certain machinery or property of the company was in good working condition and free of defects.
How is the loss measured in such a scenario?
The claim may be put both as 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 measure of damages differs according to the cause of action. In the case of a claim that there has been a breach of warranty about the quality of an asset that 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 paid. See Lord Denning MR in Doyle v Olby (Ironmongers) Ltd  2 QB 158; Karim & Anor v Wemyss  EWCA Civ 27 at .
Karim & Anor v Wemyss  EWCA Civ 27 at - is illustrative:
25. 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.
26. There is one further important difference between a claim in contract for breach of warranty and a claim in tort for misrepresentation. In the case of a claim for misrepresentation the claimant must show that he relied on the representation in deciding to enter into the contract (although the representation need not be the sole cause of the decision). However, in the case of a claim for breach of warranty all that the claimant needs to prove is that the warranty has been broken.
Generally, the measure of loss for breach of warranty (of quality) as to sale of shares is the difference between the value of the shares as warranted and the true value of the shares: Lion Nathan Ltd. v CC Bottlers Ltd  1 WLR 1438 (HL), McGregor on Damages at para. 27-008.
In the absence of contractual machinery to value the shares, the court will have to determine the appropriate way to value the aforesaid shares. This is a factual determination based on the evidence adduced. See Columbia Asia Healthcare Sdn Bhd v Hong Hin Kit Edward and another and another appeal  SGCA 3 at .
This may be by way of a Discounted Cash Flow (DCF) analysis, multiple of historical earnings (EBITDA/EBITA) by reference to profit:earnings multiplier, net assets basis, or some other valuation approach.
The value as warranted of shares is presumed to be the actual price paid for the shares unless rebutted (see Eastgate Group Ltd v Lindsey Morden Group Inc  1 WLR 642 at  and Sycamore Bidco Ltd v Breslin and another  EWHC 3443 at ; Columbia Asia Healthcare Sdn Bhd v Hong Hin Kit Edward and another and another appeal  SGCA 3 at ).
Andrew Stilton, Sale of Shares and Businesses: Law, Practice and Agreements, 5th Edn. (Sweet & Maxwell, 2018) states at para 10-03 that the determination of the market value of the shares with warranty breached is likely to depend upon the basis on which the parties arrived at the purchase price. If the purchase price was calculated based on net assets, then the loss from the breach of warranty is the difference in value of the assets. He states at para 10-03:
“The damages to which the buyer is entitled will normally be the difference between the actual market value of the business and the market value that it would have had if the warranty had been true. For example, if a buyer buys a company for £1 million and the seller warrants that all of the plant used by the company is owned by it but if after completion the buyer finds out that a major item of plant was actually on lease and the effect of that is to reduce the value of the company to £950,000, the damages to which the buyer will be entitled for breach of warranty are likely to be £50,000 … It may be more difficult to determine the market value with the warranty breached and this is likely to depend upon the basis on which the parties arrived at the purchase price … if the purchase price were determined by reference to the net assets of the company and the value of the plant in question is £50,000, then the value of the company with the warranty breached is likely to be £950,000. If, on the other hand, the purchase price had been determined by reference to the company’s profits (for example, on a multiple (a price/earnings multiple) of five times the profits for the previous financial year), then if the plant in question were repossessed by the finance company but its absence did not affect the company’s capacity to earn profits, its value may be unaffected. If however the buyer found that the company had to pay £20,000 per year in leasing payments if it wished to continue to use the plant, the reduction in the company’s value may well be five times the amount by which the company’s earnings are reduced, i.e. £100,000.”
In Senate Electrical Wholesalers Ltd. v Alcatel Submarine Networks Ltd  EWCA Civ 3534, the sale of the business was based on a purchase price comprising the net assets and goodwill of the business. There was a breach of warranty by an overstatement of the profits in the accounts. The claimant argued that a price/earning multiplier ratio methodology should have been applied to calculate the loss. The trial judge rejected this. The Court of Appeal affirmed the decision. A key reason for this decision is that the price/earning ratio was not how the purchase price was calculated.
The Court in discussing Lion Nathan Ltd v CC Bottlers  1 WLR 1438 stated at : “33. … That was a case involving a share sale. The price paid by the plaintiff was calculated on the basis of 20 times the forecast profits after tax in the company’s year of account ending 2 September 1989. The forecast for the two months in issue was warranted to have been ‘calculated on a proper basis’ and ‘was achievable based on current trends and performance’. There was a substantial shortfall. The measure of damages was assessed by multiplying the shortfall by the multiplier of 20. We can find nothing in the decision of the Privy Council or the opinion of Lord Hoffmann to indicate that this is the only way in which damages for breach of warranty or the sale of assets and goodwill in a business is to be calculated. In our view it is quite clear that if this is how the original price is calculated, it is the obvious way to calculate the damages by applying the same multiplier to the shortfall in maintainable earnings/profits.”
At : “A similar exercise was done by May J. in ADT v BDO Binder Hamlyn  BCC 808 and Jacob J. in Witter v TBP Industries  2 All ER 573 at 606. But these are also cases where the original price appears to have been calculated on a p/e basis or the experts were agreed that it was the proper basis for assessment. But in this case the judge rejected Senate’s case that the price was calculated on this basis. This was a crucial part of their case. We agree with Mr Field that this would not necessarily be fatal to the adoption of a p/e calculation to assess damages. There may be cases where it is appropriate to do so, even if the original price was not so calculated, particularly if this is the agreed approach of the valuation experts. As the passage we have cited from the judge’s judgment shows, he did consider whether Mr Swinson’s method could stand on its own. But for the reasons he gave he rejected it. It was simply not appropriate when there were so many other factors which induced CDME to pay the price they did, not least the desire to get into the UK market, to retain their position as market leaders and to keep Otra/Sonepar out. In our opinion, for all the reasons given by the judge in the passage cited he was right to reject Senate’s case as to the method of calculation of damage.”
In Ageas (UK) Ltd v Kwik-Fit (GB) Ltd & Anor  EWHC 2178 (QB), the purchase price for the shares was determined based on a DCF model which took into account the false management accounts figures: at . The court had to determine loss by the valuation of the shares as warranted and in fact. The latter was based on a valuation using the DCF model applying the true lower figures in the management accounts: see -. The court stated at : “The measure of loss for breach of warranty in a share sale agreement is the difference between the value of the shares as warranted and the true value of the shares: Lion Nathan Ltd. v C-C Bottlers Ltd  1 WLR 1438 1441F-H; Eastgate Group Ltd v Lindsey Morden Group Inc  1 WLR 1446. Each involves valuing the company. It was common ground that the value of the shares as warranted was the price which Ageas paid, namely £214.75m, which was very close to the figure produced by the DCF model using Ageas’ assumptions and key performance indicators. The dispute was what value was to be attributed to the error in relation to TOCBD.”
In The Hut Group Ltd v Nobahar-Cookson & Anor  EWHC 3842 (QB), the purchase price for shares in THG were determined based on a projection of EBITDA, which turned out to be false: see -. The parties agreed to apply a DCF model to calculate the warranty true and warranty false valuation of shares, taking into account inter alia the fact that the breach of warranty caused a planned IPO to fail, and its effect on the discount rate: see , -, -.
In The Hut Group, the court set out the principles on measure of loss at : “In the case of the quantification of damages for breach of warranty in an agreement for the sale of shares (1) The proper measure of damages is a comparison between the value of shares as warranted and their actual value, that is, “warranty true” vs. “warranty false”. (2) The normal rule is to make that comparison as at the date of the breach, which is the date of the contract, taking account only of events up to that date. (3) Where value depends on the outcome of a future contingency, the known outcome of that contingency may sometimes be taken into account. (4) However that will only be done where “necessary to give effect to the overriding compensatory principle”. (5) The prima facie rule from which departure must be justified is that damages are to be assessed at the date of breach without hindsight. (6) Hindsight cannot be used to confound the allocation of risk under the bargain. It is inappropriate for the court to deprive a buyer of the benefit of a contingency from which, under the contract, he is intended or entitled to benefit. (7) In a share purchase agreement involving a once and for all exchange of consideration, the party which receives the business or a shareholding in the business assumes the risks, or the rewards, of its subsequent performance or failure to perform. For these principles see Ageas (UK) Limited v Kwik-Fit (GB) Limited  EWHC 2178 (QB) where Popplewell J reviews the authorities, and as to the general exclusion of hindsight see Joiner v George  EWCA Civ 160 at , Sir Christopher Slade.”
The decision in Senate shows that if parties’ experts agree on a particular valuation approach, then that the court will rely on such an approach. This was the case in ADT Ltd v BDO Binder Hamlyn  BCC 808 (at 878– 879). Both experts had agreed that a discounted cash flow valuation could not be done and that if such calculations could not be done, valuations of companies seen as going concerns usually proceeded by estimating maintainable profits and applying a price earnings multiple: see Columbia Asia Healthcare Sdn Bhd v Hong Hin Kit Edward and another and another appeal  SGCA 3 at .
Oversea-Chinese Banking Corporation Ltd v ING Bank N.V  EWHC 676 (Comm) supports the proposition that where a seller of a business gave a warranty as to undisclosed liabilities, that loss may be measured by reference to the amount of the undisclosed liabilities, and that this follows from the established principle on loss for breach of warranty of shares i.e. the diminution in value of the shares as warranted: at . However, the claimant must allege such diminution and adduce expert valuation evidence on the value of the shares as warranted and the value of shares in fact (taking into account the undisclosed liabilities).
This case concerned a claim by OCBC against ING for breach of warranty under a sale and purchase agreement in relation to failure to disclose in the accounts, liabilities of the target company, IAPBL, to a third party LBF. The court had to consider inter alia at  whether the measure of damages sought to be recovered can be recovered as a matter of law.
OCBC claims that if not for the breach of warranty in the Agreement, the accounts would have disclosed the liability to LBF and OCBC would have obtained an indemnity in the Agreement in respect of IAPBL’s liability to LBF and thus OCBC would have been able to recover the $14.5 million paid out by IAPBL to LBF: . (In other words, OCBC argued it would have negotiated a hypothetical indemnity.)
ING argued that for breach of warranty in the sale of shares, it is well-established that the purchaser is entitled to recover the difference between the true value of the shares and the value of the shares as warranted: . ING relied at - on the cases of Wemyss v Karim  EWCA Civ 27, -, Ageas (UK) Ltd v Kwik-Fit (GB) Ltd  Bus LR 1338; The Hut Group Ltd v Nobahar-Cookson  EWHC 3842 (QB); Zayo Group v Ainger  EWHC 2542 (Comm) .
OCBC argued that the normal measure of damages for breach of warranty as to the truth and fairness of accounts in a share sale agreement is the estimated loss directly and naturally resulting from the breach of warranty, and that the diminution in value of shares is not the only measure of loss: at , . OCBC argued that the diminution in value rule is only prima facie and can be departed from: -. The Court rejected OCBC’s arguments.
“35. OCBC in support of its contention that s.53(3) is only a prima facie rule referred to Butterworths Common Law Series The Law of Damages at 22.102 where the example was given that where a seller of a business gave a warranty as to undisclosed liabilities, that loss may be measured by reference to the amount of the undisclosed liabilities. However, in my view this is consistent with the principle that the buyer should be compensated for his loss of bargain and such actual liabilities go to the diminution of the value of the asset. By contrast in this case no diminution in the value of the shares is alleged by reason of the (alleged) undisclosed liabilities to LBF. …
38. In Karim, the Court of Appeal clearly stated that the measure of damages for breach of warranty in these circumstances is the difference between the true value of the asset and its value with the quality warranted:
40. … the claim for damages which would have been recovered under a hypothetical indemnity which would have been negotiated had the 2008 Accounts included provision for the potential liability to LBF is not recoverable as a measure of damages for breach of a warranty as to quality on a share sale.”