Tax Indemnity Claims: Complying With the Notice Provisions in ‘Full-Recourse’ and ‘W&I-Backed’ M&A Deals

Bringing a contractual claim following the successful conclusion of an M&A transaction is sometimes unavoidable.  It is important to avoid falling at the first hurdle by filing an invalid claim notice.

As noted by our colleagues in a previous blog post (here), as soon as a purchaser uncovers a potential contractual claim under a SPA – be it a tax indemnity claim, a claim for breach of warranty, or something else – it will be important for them to identify and comply with applicable notice requirements.  Getting this wrong can open the door to legal proceedings on procedural grounds: the UK courts have made it clear that a failure to provide valid notification of claims won’t be overlooked as mere technicality and this can lead to claims being dismissed regardless of their substantive merit. 

In this blog post, we explore what this means in practice for purchasers in both ‘full-recourse’ and ‘W&I-backed’ English law-governed M&A deals.

Interpreting contractual notice provisions

There have been a significant number of cases that have come – and continue to come – through the UK courts on the interpretation of provisions regarding the notification requirements for contractual claims.  Many of them stress the same overarching point: it is the specific wording of the provision in question which matters, such that there is no ‘one-size-fits-all’ approach that a purchaser must follow to successfully notify a seller of a contractual claim.  However, there are some points of universal application coming out of this body of case law that purchasers should bear in mind when applying the contractual provision in front of them.  We explored this in a previous blog post in more detail here, but by way of summary:

1. Be clear that a claim is being made

Purchasers should ensure that any notice they send makes it clear that they are 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.

Purchasers should take particular care here if they are making a claim in respect of a contingent tax liability.  To be valid, the notice must make it clear that they are making a claim now, rather than merely warning that a claim may be brought in the future.

2. Provide sufficient detail about the claim

The level of detail required to be provided about the claim will turn on the wording of the notification clause itself.  However, when interpreting such wording, one should start from the proposition that its purpose must be to ensure the recipient is able to make an informed assessment of the claim and take the appropriate next steps. 

If in doubt as to what is required by the contractual provision, it is generally better for purchasers to write too much rather than too little – covering as a starting point (where possible): (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.

3. Properly estimate the quantum of the claim

Purchasers should carefully consider whether the notification clause requires an estimate of quantum, noting that neither the absence of an explicit requirement to do so, nor the fact that an estimate may be difficult to calculate, necessarily means that such an estimate can be omitted from the notice of claim. 

If an estimate is required, purchasers should ensure they are using the right measure of damages when putting together the calculation – indemnity and warranty claims should not be conflated in this respect.

4. Take care when making multiple claims

Unless the notification clause says otherwise, a single notice can be given for multiple claims (including where those multiple claims relate to the same underlying loss but there are different heads of claim, for example under a warranty and also under an indemnity). However, purchasers should ensure that such a composite notice gives sufficient detail about each claim being made – including, if an estimate of quantum is required, by including separate figures for each claim (rather than one aggregate number).

5. Serve the notice of claim correctly

Finally, purchasers should ensure that notice is served within the appropriate time limits and by permitted methods as prescribed by the contract.  Purchasers should take particular notice of any provisions in the contract which govern when notice will be deemed to have been served (which may be different depending on the service method). 

What about W&I backed tax indemnities?

The foregoing summarises some of the points which purchasers should consider when notifying sellers of tax indemnity (or other contractual) claims – but what is the position in ‘limited recourse’ M&A transactions, where the liability of the seller is capped (for example, at £1) and the purchaser takes out W&I insurance to cover unknown risks?  It is particularly important for affected purchasers to understand the differences in approach as between these two scenarios in the tax context, given a recent market claims study by HWF Partners found that more notifications made under W&I insurance policies relate to breaches of tax warranties than warranties of any other type.

(The following observations reflect the current position in the UK W&I market; the position in other markets may be different.)

The starting point should always be the W&I insurance policy in question.  It would be unusual for an insurer to require a purchaser to serve a contractual notice vis-à-vis a seller under the transaction documents in order to bring an insurance claim (especially if the seller’s liability is capped at £1). Those contractual notification provisions are instead generally ‘switched off’ under the policy and it is the notification provisions in the policy itself that are relevant.

The critical point for a purchaser is to ensure that they serve any claim notice on the insurer before the expiry of the relevant policy period. Purchasers should check the notice provisions in the insurance policy and make sure these are complied with.

However, there are typically fewer bear traps to watch out for in relation to the content of that claim notice (as compared to notifying a seller).

An insurer typically wants to be notified about a potential claim or matter that could give rise to a claim as early as possible so that it can consider whether and how to invoke its conduct rights. The notification provisions in W&I policies are generally drafted with this overarching point in mind, on the basis that the insurer would like to receive whatever information is available whenever it becomes available without particularly looking to trip up the purchaser over a technicality.

Therefore, the purchaser may be obliged to serve a claim notice on the insurer soon after a tax audit or enquiry has commenced which could give rise to an insured loss. That claim notice would typically need to include information to the extent it is in the possession of the purchaser, but often an express statement will be included in the policy to the effect that a failure to provide all of that information will not prejudice the claim and that a delay in providing a claim notice will not preclude a claim unless and to the extent that that delay prejudices the insurers.

Once a claim notice has been served within the policy period, even if that claim notice only refers to the opening of a tax audit or enquiry, it is often expressly acknowledged in the policy that any subsequent loss arising out of that tax audit or enquiry will be deemed to have been notified at the time of the original claim notice. A purchaser may also be permitted to supplement a claim notice with further information at a later point in time.

It is therefore best practice for a purchaser to consider notifying the W&I insurer as soon as practicable after a tax audit, investigation or enquiry is commenced which could give rise to an insured loss and consider providing the insurer with whatever information it may have about that matter at that point in time.

Freshfields has in-depth experience on both the buy- and sell-side of M&A disputes. This is the fourth blog published in our series on M&A disputes: M&A Earnout Provisions: Recent Trends in US Law and How to Draft Your Clause to Avoid Disputes, The Curious Case of Crossover Witnesses in Post-M&A Arbitration and Is It a Done Deal? Breach of Warranty Claims: How to Protect Your Position.

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