Warranties & representations – clarity is key

Posted on
The recent case of Idemitsu Kosan Co Ltd v Sumitomo Corporation [2016] EWHC Comm serves as a useful reminder to clearly distinguish between warranties and representations in contracts. Suppliers are also reminded to include a well drafted entire agreement clause.

Warranties

It is common for suppliers to grant warranties to the customer in respect of the goods or services they are supplying under a contract. A warranty is a contractual promise that a particular statement regarding the goods or services is true as at the date of the contract. An example of a typical warranty found in a software supply agreement is “the software will be free from material defects”. If this warranty is untrue then the supplier will be in breach of contract and the customer will be entitled to bring a claim for damages. A breach of a warranty by the supplier does not though generally give rise to a right for the customer to terminate the contract unless the customer can prove that the warranty amounts to a condition i.e. a term of a contract which is of such vital importance that it goes to the root of the transaction.

Damages for a breach of contract claim are assessed to put the customer in the position it would have been in if the warranty had been true. However, in order to prove its damages, the customer must demonstrate that its losses were in the reasonable contemplation of the parties at the time the relevant contract was entered into[1].

Representations

A representation, like a warranty, is a statement of fact but is one which is made during contractual negotiations in order to induce the other party to enter into the contract, rather than at the time the contract is made. Whilst representations are usually made prior to the contract they can still be repeated in the contract and therefore form the basis of a contract i.e. “the seller warrants and represents that…”.

The distinction between warranties and representations is important because if a representation is found to be untrue then the customer will be entitled to bring a tortious claim for misrepresentation, which if successful would allow the customer to rescind the contract and bring a claim for damages. Rescinding the contract means that the contract is set aside and the parties are put back into the position they were in before the contract was made. This is generally a more advantageous remedy for the customer in comparison to the damages available for a breach of contract claim, which simply compensates the customer for the losses resulting from the breach.

Another key difference between warranties and representations is that the customer does not have to prove the damages were in the reasonable contemplation of the parties at the time the contract was entered into in order to recover them. The damages must though still be “reasonably foreseeable” by the parties, but this has been held by the courts to be a less onerous test than the reasonable contemplation test associated with breach of contract claims[2]. Due to the fact that the reasonably foreseeable test for a misrepresentation claim is assessed at the time of the breach rather than retrospectively at the time the contract was entered into, it should be easier for the customer to prove that any losses were foreseeable. This means that a loss that is too remote in contract might still be recovered in a misrepresentation claim.

The manner in which damages are calculated in a misrepresentation claim could also benefit the customer. Damages awarded for a breach of a warranty will be assessed from the date of the breach, whereas damages resulting from a misrepresentation claim are assessed from the date the misrepresentation was made. If the supplier has made the representation prior to the commencement of the contract then any damages will be measured from an earlier date than for breach of contract and this may give rise to a higher level of damages. It should also be noted that if the customer can prove that a misrepresentation has been made on a fraudulent basis then the supplier will not be able to rely on any contractual limitation of liability as any exclusion of losses resulting from fraudulent misrepresentation is unlawful.

Given the potential to be able to rescind the contract and also to claim higher levels of damages, it is usually favourable to the customer if the warranties also amount to representations. Whether the customer is able to state the warranties as representations will though depend on the bargaining strength of the parties.

Idemitsu v Sumitomo

In the case of Idemitsu v Sumitomo the claimant purchased the entire issued share capital of Petro Summit Investment UK Ltd from the defendant. The share purchase agreement (SPA) included a schedule of warranties regarding the target company, which were found to be untrue sometime after the limitation period for bringing a breach of contract specified in the SPA had expired. To avoid the contractual limitation period, the claimant instead brought a tortious claim for misrepresentation by arguing that the warranties also amounted to representations made by the defendant.

In reaching its decision, the court reviewed the conflicting positions outlined in the leading cases of Invertec Ltd v De Mol Holding BV [2009] EWHC (Ch) and Sycamore Bidco Ltd v Breslin & Anor [2012] EWHC (Ch). In Invertec, Arnold J held that warranties contained in an SPA were also capable of being interpreted as representations regarding the state of the company and these representations had induced the buyer into entering the SPA. Conversely, in Sycamore the court gave greater importance to the natural meaning of the drafting used in the contract. As the draftsman would have been aware of the legal distinction between warranties and representations and chose not to describe the warranties as representations in the clause, the court held that it was not the intention of the parties for the warranties to amount to representations. 

In Idemitsu, the court preferred to follow the reasoning in Sycamore and granted a summary judgment dismissing the claim. The court held that it is a basic underlying premise that the act of concluding a contract should not detract from the terms agreed by the parties and if the parties had intended the warranties to amount to representations they would have agreed to draft the clause in this way. This means that the natural meaning of the drafting is the primary factor regardless of whether a warranty is capable of amounting to a representation.

That said, the court accepted that in some circumstances it could be possible for a warranty contained within a draft contract which has been shared by a party during negotiations to amount to a representation if this draft warranty has induced the other party into entering the contract when the execution copy is signed. This was however not the case in Idemitsu as the court held that the entire agreement clause was drafted to dismiss any such pre-contractual representations.

Comment

The court’s decision in Idemitsu provides some clarity that a warranty will not usually be held to be a representation unless the clause expressly states that to be the case. It also serves as a useful reminder of the distinction between the remedies available for a tortious misrepresentation claim and a claim for breach of contract and the importance of the parties clearly agreeing what remedies will be available to the customer in the event of a supplier breach.

Suppliers should also note the importance of including a well drafted entire agreement clause that excludes liability for misrepresentation from both pre-contractual statements and from the terms of the contract itself.



[1] (Hadley v Baxendale ([1854] 9 Ex 341)).

[2] Note, the customer will not be required to meet the test of reasonably foreseeable if the misrepresentation has been made on a fraudulent basis. Damages will instead be awarded for all losses directly flowing from the misrepresentation, even if those losses are unforeseen.