Claims under a tax indemnity: the importance of the notice provisions

After intense negotiations, the acquisition of the target finally completes.  Everyone is delighted.  The purchaser takes control of the business, the post-completion formalities are dealt with, and the contracts are filed away.

So far, so good.

Then, trouble hits –the target company becomes liable for a major, unexpected tax liability relating to an event pre-dating the acquisition. 

As the purchaser’s in-house counsel, you dig out the contracts, locate the tax indemnity, and conclude a claim can probably be made against the seller.  You draft a letter to the seller notifying the claim and turn your attention elsewhere.

Stop.

It is easy to overlook the procedural requirements, but it is vital to get this right.  In recent years, the courts have made it clear that a failure to provide valid notification of claims is unlikely to be overlooked and often leads to claims being dismissed regardless of their substantive merit.  These decisions normally turn on the specific wording of the notification requirements in the underlying contract, but there are some points of universal application that should be borne in mind. 

These points are equally worthy of consideration by a seller receiving a notice of claim from a purchaser under a tax indemnity – the first point to check, before considering the merits of the claim, is whether the notice received has been validly issued in accordance with the underlying contract.

Tip 1: Be clear that a claim is being made

It might sound obvious, but an important first step is to ensure that any notice a purchaser sends to a seller makes it clear that the purchaser is making a claim against the seller.  It is not enough that the purchaser intended the notice to inform the seller of this; for valid notice to be given, a hypothetical ‘reasonable recipient’ of that notice must understand that such a claim is in fact being made.  Is the draft notice clear that it is a notice of claim, rather than any sort of contractual information notice?

Particular care should be taken if a purchaser is making a claim in respect of a contingent tax liability (e.g. because a tax audit is ongoing but no assessment has yet been issued).  To be valid, the notice must make it clear that the purchaser is making a claim now, rather than merely indicating that a claim may be brought in the future.  The language used is important here: describing a contingent liability claim as ‘a claim for a potential liability to tax’ is likely to meet this requirement; describing it as ‘a potential claim’ is unlikely to do so.

Tip 2:  Provide sufficient detail about the claim

Even if the notice is clear that a claim is being made, it will only be valid if it also contains sufficient detail about the claim itself.  Although there are no blanket rules in this regard – the level of detail required will turn on the wording of the notification clause itself – there are some points of general application to bear in mind:

• Read the contract.  The test is whether the purchaser has complied with the requirements of the notification clause, not whether it has provided as much information as possible or as much information as would need to be included in the particulars of claim if the matter were to be litigated. 
• Err on the side of caution.  The burden will lie with the purchaser to prove it provided valid notice.  Accordingly, from the perspective of the purchaser, it is generally better to write too much rather than too little – and if in any doubt as to what the notification clause requires, it is typically worth covering as a starting point: (a) the legal basis of the claim, (b) the facts, events and circumstances on which the claim is based, and (c) an estimate of the quantum of the claim.
• Remember the purpose of notices.  When a court interprets a notification clause, it will start from the proposition that its purpose is to ensure the recipient is able to make an informed assessment of the claim and take the appropriate next steps.  Does the draft notice achieve that?

Tip 3:  Properly estimate the quantum of the claim

A common pitfall for purchasers when preparing a notice of claim is to fail to provide an estimate of quantum.  Some notification clauses will explicitly state that notices must include such an estimate, but be aware that the absence of this specific requirement does not necessarily mean an estimate of quantum can be omitted; for example, courts have held that an obligation to provide details of ‘the particulars of the claim’ requires an estimate of quantum to be included.

What if it is incredibly difficult to accurately estimate the quantum of the claim at this early stage?  The notification clause might anticipate this, by requiring the provision of an estimate of quantum where ‘reasonably practicable’.  But even in the absence of such a qualifier, the requirement to provide an estimate cannot simply be dispensed with – an estimate should still be provided, however approximate or caveated that might be.

If an estimate of the quantum of the claim is required, make sure the right thing has been estimated – is the claim being brought under an indemnity (i.e. pound-for-pound recovery) or a warranty (i.e. recovery based on the diminution of the value of the acquired shares)?

Tip 4:  Take care when making multiple claims

The purchaser may wish to give notice of multiple claims (tax or otherwise) at the same time.  Can that be done via a single notice?  Unless the notification clause says otherwise, yes – but the purchaser should proceed with caution.  To be valid, the notice must give sufficient detail about each individual claim being made.  Put another way, does the draft notice give the seller enough information to assess each claim separately?  For example, if an estimate of quantum is required, make sure separate figures for each claim rather than one aggregate number are provided.

Tip 5:  Serve the notice of claim correctly

Ensure the final hurdle is cleared – the purchaser should ensure that notice is served within the appropriate time limits and by permitted methods.  What this means in practice depends on the requirements imposed by the contracts, but remember:

• Trying isn’t always enough.  If actual service is required under the SPA, a reasonable attempt to serve the notice is unlikely to be sufficient (even if the seller is responsible for that reasonable attempt failing).
• Serve on all relevant parties.  The purchaser should check which parties must be served notice, and the relevant individuals to which notice given to a party must be addressed, and make sure to serve notice on all of them regardless of whether the recipient is a person against whom the claim is being brought.  This risk is particularly acute if there were a number of individual sellers as part of the transaction – depending on the language used in the notification provision, and whether there is a ‘seller representative’ concept in the documentation, failing to serve notice on each of them individually may lead to the notice as a whole being invalid.
• Read the time limits carefully.  For example, an obligation to serve notice by a particular date and ‘as soon as possible’ imposes a dual condition for valid notice – compliance with both limbs of the clause will be required.

It sounds a little trite to say that perhaps the most important message here is to pay close attention to the contractual requirements, but following them to the letter should help to avoid issues with the validity of notice given for a tax claim.

If you would like to discuss any of the points raised in this blog post in further detail, please contact our tax investigations and dispute team or your usual Freshfields contact. 

An overview of how ensuring compliance with notification clauses fits into the broader topic of making, or defending, claims brought under a tax indemnity, is included in our Contentious Tax Tool.  This tool helps navigate risks arising on tax-related disputes and investigations by operating as a checklist to consult both when a tax dispute is on the horizon or a new issue arises on an ongoing dispute.  For further details and to request access to our Contentious Tax Tool, please contact TaxDisputes@freshfields.com.