Representations and Warranties in Cross-Border Mergers and Acquisitions The Challenges of Cultural Diversity
The acquisition of businesses through share purchase transactions is a complex process in any event, and especially when it is conducted across borders and involves countries with contrasting legal regimes. The representations and warranties made by the seller are but one aspect of such transactions, but often the most extensively negotiated part of the deal. The disputes that may occur over breaches of those representations and warranties raise many practical and theoretical problems, especially when different jurisdictions are involved. The purpose of this article is not to give a comprehensive picture of common law and civil law solutions to those problems but rather to discuss how breaches of representations and warranties may be perceived differently by parties from different backgrounds and resolved differently depending on the applicable law. Our comments will focus primarily on transactions involving shares as opposed to assets, which raise less complicated issues in relation to representations and warranties.
The vast majority of disputes arising out of M&A transactions are resolved outside State courts. Arbitration is favoured by parties looking for expediency, confidentiality, a good understanding of business needs in M&A transactions on the part of the tribunal, and a spirit of cooperation that at best could lead to a settlement and will otherwise result in a fair and equitable award under applicable law.
This article addresses three matters fundamental to resolving disputes over representations and warranties in cross-border M&A transactions:
- the nature of representations and warranties
- the rights arising from representations and warranties and the remedies available in the event of their breach
- the damages awarded to compensate for breaches of representations and warranties.
Although rooted in the common law system, representations and warranties are also known and used in countries belonging to the civil law tradition. However, they are not necessarily apprehended in the same way, as will become apparent form our references to different laws and in particular the Polish law we know best and which we will use as an illustration of a civil law system (see B. Gessel-Kalinowska vel Kalisz, Oświadczenia I zapewnienia w umowie sprzedaży udziałów w spółce z ograniczoną odpowiedzialnością (w świetle zasady swobody umów) (Woletrs Kluwer, 2010).
1. Nature of representations and warranties
1.1. Genesis: caveat emptor
Although the practice of making representations and warranties in international commerce originates from the common law system, it has been widely adopted in civil law system, too. The ICC Model Mergers and Acquisitions Contract (Share Purchase Agreement), which was produced by the ICC commission on commercial Law and Practice and is the fruit of collaboration between lawyers from England, France, Germany, India, Italy, the Netherlands, Sweden and Turkey, offers an example of osmosis between the two systems (ICC Model Mergers & Acquisitions Contract: 1 Share Purchase Agreement, ICC Publication 656 (2004) [hereinafter ICC Model Contract], available from www.iccbooks.com). While representations and warranties may be similarly worded in the two systems, they may be construed and applied differently in different jurisdictions and may produce different effects.
Representations and warranties as used in the common law system reflect the belief that it is for the buyer to decide to what extent its interests should be protected in the event that the object sold is defective of has a lower value than expected (see R. Thompson, ed., Sinclair on Warranties and Indemnities on Share and Asset Sales (London: Sweet & Maxwell, 2005) [hereinafter Sinclair on Warranties] at 1. This belief is expressed in the Latin phrase caveat emptor, meaning ‘let the buyer beware’. As a rule, there are no statutory provisions to cover this need in common law system, save certain exceptions where the applicable law affords special protection to the buyer in a sales contract. One such exception is the US Uniform Commercial Code, section 8.306 of which sets out the warranties provided by a person guaranteeing the endorsement of a share certificate. In general, however, the seller is under no obligation to inform the buyer about facts or circumstances related to the object sold, even if it becomes obvious in the course of negotiations that the buyer lacks knowledge about certain material characteristics of that object (see E. McKendrick, Contract Law: text, Cases and Materials (Oxford University Press, 2005) at 260ff; however, the seller will be obliged to inform the buyer about the terms of its offer in the event of a mistake). Indeed, English law does not even admit that parties should act in good faith in this regard (ibid. at 264). Representations and warranties are designed to overcome such insufficiencies, their main aim being to protect the buyer if its purchase turns out to be a lower value than expected (Sinclair on Warranties, supra note 3 at 1).
The position is different in certain civil law systems. German law, for example, places an obligation on the seller to inform the buyer about the legal characteristics of the object sold without having to be asked for that information (§ 444 of the Bürgerliches Gesetzbuch (BGB, German Civil Code) in force until 31 December 2001. Although this provision was removed in the 2001 reform, the obligation continues to exist, see Palandt / Weicienkaff, Bürgerliches Gesetzbuch, 69th ed. (Munich, 2010) § 433 note 24ff). Polish law goes even further. Under Article 546(1) of the Polish Civil Code, a seller is required to provide any and all necessary information not only in relation to the legal, but also the factual status of the object sold. In a decision handed down on 6 June 2000, the Polish Supreme Court held that the fact that the machine sold was manufactured the subsequent maintenance of the machine (I CKN 760/98, Lex No. 50889). Although this example does not relate directly to the sale of shares, it demonstrates just how far the duties of the seller may go under Polish law. Similarly, under French law, the seller is subject to broad obligations aimed at preventing fraud (dol) and ensuring that contracts are made in good faith (see P.D.V. Marsh, Comparative Contract Law (Aldershot: Gower, 1994) at 127-130).
The substantive content of representations and warranties will depend on the intentions of the parties, the allocation of risk and the type of business to which the transaction relates.
In share purchase agreements, the seller’s representations and warranties usually cover the following: (i) the extent of the information disclosed to the buyer as part of the due diligence process, (ii)the seller’s capacity to enter into the agreement, (iii) the legal status of the shares, (iv the legal status of the entity whose shares are being acquired, and (v) the state of that entity’s business, including a description of its assets and liabilities (for examples see the model share purchase agreements in Model Stock Purchase Agreement with Commentary produced by the Mergers & Acquisitions Committee of the American Bar Association Business Law Section: Sinclair on Warranties, supra note 3; ICC Model Contract, supra note 2).
When a share purchase agreement relates to the sale of shares in a holding company that belong to a group of companies, the value and price of its shares might depend on the value of the corporate group. In such cases, the representations and warranties may be made for each company in the group separately or on a consolidated basis.
The representations and warranties contained in a share purchase agreement may be of an unlimited nature. The seller may, for instance, assert that the financial statements of the target company are true and correct in all respects. In order to mitigate the consequences of such a sweeping statement, the seller may qualify the warranty by referring to the extent of its knowledge, materiality, or other criteria such as an appropriate value or a given point in time. For example, the seller may affirm that the financial statement are true and correct in all material respects or that any variation therefrom shall not exceed a certain amount or percentage.
In practice, parties tend not to negotiate limitations for particular warranties but rather to set down limitations applicable to representations and warranties as a whole. Such limitations sometimes specify the maximum value of the seller’s liability (practice shows that this may vary from 20% to 100% of the purchase price) or, where minor claims are concerned, a minimum value for each claim or the aggregate of all claims (so-called ‘floors’ and ‘ceilings’).
1.4. Distinction between representation and warranty
In the common law system, representations and warranties are treated as two distinct legal concepts (on the difference between representation an warranty, see Black’s Law Dictionary, see also Sinclair on Warranties, supra note 3 at 3-4). A representation is a statement of knowledge about the factual or legal status (see E. McKendrick, supra note 4 at 273) of the object sold, the purpose of which is to induce a person to enter into an agreement. The representation may refer to both a past and a current situation and may be made explicitly by way of a contractual clause or in a pre-contractual document, or implicitly through a gesture or a smile (ibid. at 261). If the representation is false, its author is liable in tort (on the arbitrability or tort claims, see F. Gonzales, ‘The Treatment of Tort in ICC Arbitral Awards’ (2002) 13:2 ICC ICArb. Bull. 39. On 5 February 2009, the Polish Supreme Court held that the jurisdiction of the arbitral tribunal covers all claims related to performance of the contract, including claims for damages for breach of contract, unjustified enrichment and claims in tort, provided they result from the event constituting the breach of contract (I CSK 311/08, Lex No. 492144). The scope of such liability will depend on the degree of wrongdoing. A distinctin amy be made between fraudulent, negligent and innocent misrepresentation. The misrepresentation need not necessarily be made by a contracting party; for instance, it could be made by an accountant retained by the purchaser to audit the financial statements of the target company (see JEB Fasteners v. Marks, Bloom & Co  1 All E.R. 583).
A warranty is an assurance that a given statement is true and, if the statement is false, creates an obligation to make good any damage suffered by the recipient of the warranty who entered into the agreement on the basis of that warranty (see K.A. Adams, ‘A lesson in drafting contracts: What’s up with “representations and warranties”?’ Business Law Today (Nov./Dec. 2005). In other words, a warranty is a representation treated as a contractual commitment.
An indemnity is a special kind of warranty sometimes used by buyers to strengthen their position. An indemnity allows a buyer to enforce its rights when a warranty turns out to be untrue, without having to prove the damage suffered and regardless of the buyer’s actual knowledge. The question of indemnities will not be further analysed in this article (on the origin and legal nature of indemnities, see Sinclair on Warranties, supra note 3 at 3-4).
1.5. Self-regulatory nature
Parties commonly set out representations and warranties in lengthy attachments to their contract and go into great detail over the consequences of breaching representations and warranties. Given the different approaches national laws take to the subject, a detailed description of what events amount to a breach and of what remedies can be exercised is very important. Although national laws will generally come into play only to fill gaps in the contract, there is a risk that go against the parties’ intentions and arbitrators cannot disregard such provisions unless they are authorized to decide ex aequo et bono.
‘Entire agreement’ clauses (generally on ‘entire agreement’ clauses see W.J.L. Knight, The Acquisition of Private Companies (Longman, 1992) at 123; Sinclair on Warranties, supra note 3 at 19) may be affected by the risk described above. During the negotiation of a transaction and the due diligence, the purchaser is given many documents and information, including financial statements and forecasts, copies of contracts, correspondence, notifications and calculations. An ‘entire agreement’ clause is a means by which the seller limits its liability for inaccuracy to information specifically mentioned in the agreement, as opposed to all the information exchanged. However, such clauses are not always regarded as being effective (see part 2.1.2. below).
1.6. Statutory warranties
Share purchase transactions may be subject to statutory warranties applicable to sales. This raises a preliminary question as to whether shares can be considered as objects that may have physical and legal defects and can therefore be covered by the protection which statutory warranties seek to offer the buyer.
There has been debate in Poland as to whether shares may have physical defects, in particular defects resulting from inaccurate warranties relating to the target company’s business. Objectors pointed out that, as rights, shares are immaterial and cannot have physical defects, and that in a share deal it is the shares, not the business (as in an asset deal), that are transferred. Such arguments cannot stand, given the wording of Article 556(1) of the Polish Civil Code, which simply refers to lack of the promised features of the object sld. In the case of shares, the object is not only a right but also the entire physical situation to which that right relates, including the target’s business. A change in the valuation or utility of shares can be appraised only by taking into account the physical situation to which the shares relate (B. Gessel-Kalinowska vel Kalisz, supranote 1 at 287ff). The same can be said of other rights, including the basic right of ownership of a given thing: a right to ownership of an asset may not exist without the asset to which the right relates.
The sale of shares therefore comes within the scope of the statutory warranties provided in Articles 556(1) and 556(2) of the Polish Civil Code (Law of 23 April 1964 – Polish Civil Code (Polish Journal of Laws Dz.U. 1964, No. 16, item 93, with subsequent amendments). Art. 556 concerns things and applies mutatis mutandis to shares and other rights pursuant to Art. 555). If the warranties are infringed, they trigger legal liability for physical defects meaning that the shares lack the features of whch the seller assured the buyer (dicta et promissa). The seller is additionally responsible for legal defectsaffecting the shares such as lack of title, encumbrance arising from third-party rights, or the very inexistence of the shares. Other legal defects, not expressly specified in the law, may be the subject of further contractual warranties.
Under German law (BGB, § 434), an object is considered free of physical defects if it possesses certain agreed qualities, namely that it can be used as agreed or in accordance with customary usage or what can normally be expected of such an object (like Polish law, BGB § 453(1) states that provisions relating to the purchase of things also apply to the acquisition of rights). Various approaches have been taken to the sale of shares. One approach was to consider that the buyer is entitled to bring claims under the statutory warranty for physical and legal defects related to the business. Another approach was to consider that claims are valid only if the agreement specifies the characteristic features of the company’s business. A third, extreme, approach was to consider the statutory warranty as excluded in relation to businesses (see G. Picot, ed., Unternehmenskauf und Restrukturierung. Handbuch zum Wirtschaftsrecht (Munich, 2004) at 133; with respect to intermediary opinions, see H.J. Knott, Unternehmenskauf nach der Schuldrechtsreform, NZG 2001, p. 250). It may be argued in favour of the first approach that defects are a subjective matter and concern not only the characteristics of the object sold, but also its ability to be used for purposes that lie beyond the object itself. It is also pointed out that the price agreed for the purchase of shares usually reflects the value of the enterprise ‘embodied’ in the right attached to the shares.
It has also been argued that there is no reason to depart from the rules protecting the buyer where the sale relates to a company’s shares rather than the company’s business directly Consequently, in a share purchase agreement relating to the sale of a controlling interest in the business (and only in this case), it should be possible to pursue liability for defects in the business. Opinions differ as to what constitutes a controlling interest: they range from anything over 50% as the lower limit to 99,6% as the upper limit (G. Picot,supra note 24 at 132-134).
2. Rights and remedies
2.1. Types of claims
2.1.1. Common law
Incorrect representations and warranties made in a share purchase agreement may give rise to liability in tort (for representations) or contractual liability (for warranties). One is not exclusive of the other (see Sinclair on Warranties, supra note 3 at 18).
Where a claim concerns misrepresentation, the victim’s remedy is to rescind the contract (see E. McKendrick, supra note 4 at 285-288). If the misrepresentation is negligent, the purchaser may alternatively or in addition claim damages; if the misrepresentation is innocent, damages maybe awarded in lieu of rescission.
Where contractual liability is concerned, the basic claim will be for damages and the rescission of the contract will be an exception (on ex contrctu liability, ibid. at 411-419).
Rescission will have an ex tunc effect (from then onwards,i.e. retroactive) in the case of misrepresentation and an ex nunc effect (from now onwards) in the case of warranties (ibid. at 181ff). The right to rescind a share purchase agreement will be of little relevance to the buyer of shares in the post-closing phase of an M&A transaction. Rescission presupposes that it is still possible to restore the state – both factual and legal – that existed prior to execution of the agreement. As living entities, companies are subject to constant change in the course of their business operations, so it is highly unlikely that the seller could be returned to the position it was in prior to the transfer of ownership of the shares and might well find itself in a worse position (see Sinclair on Warranties, supra note 3 at 19-20).
2.2.2. Civil law – the Polish example
The statutory warranty provided in the Polish Civil Code is not dependent on the seller’s fault or knowledge (see W.J. Katner in System Prawa Prywatnego, vol. 7 at 129; also J. Frąckowiak, ‘Uprawnienia z rękojmi za wady fizyczne rzeczy sprzedanej’, Acta Universitatis Wratislaviensis (2004) LXIV Przegląd Prawa i Administracji 30) and, as a rule, is regardless of whether the buyer suffers any damage. Hence, from a functional point of view, it is more akin to liquidated damages, insurance agreements, innominate guarantee agreements and indemnities. According to the Polish Civil Code, the buyer is entitled to the Polish Civil Code, the buyer is entitled to the basic remedies when faced with defective rights: (i) rescission of the share purchase agreement and (ii) a discount on the purchase price (Article 560(1) of the Civil Code).
Under Polish law, untrue warranties will not trigger a price reduction if the inaccuracy has no impact on the price as calculated pursuant to the contract. A similar finding was made by the arbitral tribunal in ICC Case 11539 (an extract from this award is published in this issue of the Bulletin, see paragraphs 141-153), where the seller warranted that there was no material adverse change in the financial position of the target during a specified period of time. It turned out that there was sharp decline in the target’s sales. However, the arbitral tribunal found that turnover was not an essential factor in determining the purchase price, which depended on other factors like synergies between the companies, market positioning and a related material contract.
In addition to the statutory warranty remedies of rescission and price reduction, the remedy of damages is also available under Article 566 and 574 of the Polish Civil Code. Further, the buyer may also seek damages for inaccurate representations and warranties on the grounds of a breach of contract pursuant to general provisions of law (Articles 471 et seq, of the Polish Civil Code). In such case, it is necessary to provide proof of the breach (inaccurate warranty), the damage and the causal link between the two. It is also possible to claim damages in tort (Article 415 of the Polish Civil Code) and to seek rescission on the grounds of a fundamental error committed by the buyer (Article 84 et seq. of the Polish Civil Code), although this is much less frequent in practice.
2.3. Limitations upon claims
Parties are free to determine to conditions under which contractual claims are pursued (e.g. by making them subject to time limits of criteria relating to their value). By contrast, tortious liability is subject to statutory law. Under section 3 of the English Misrepresentation Act 1967, parties cannot exclude liability for misrepresentations made in the course of pre-contractual negotiations unless it can be shown that such exclusions unless it can be shown that such exclusion is fair and reasonable. Case law is undecided as to weather a standard ‘entire agreement’ clause in the parties’ subsequent contract meets the fairness test. The initial trend was to interpret such clauses as being ineffectual in excluding liability (see Thomas Witter Ltd v TBP Industries Ltd  a All E.R. 573). However, the courts began to take a less harsh approach in the late 1990s (see E.A. Grimstead & Son Ltd. V. McGarrigan [1998-99] Info. T.L.R. 384, Government of Zanzibar v. British Aerospace  1 WLR 2333 and Watford Electronics Ltd.  E.W.C.A. Civ. 317). It may be assumed that, where parties to a share purchase agreement are business entities and rely on professional advisers, the ‘entire agreement’ clause will meet the test of fairness and reasonableness.
If the buyer was aware that a warranty was false, what effect will this have on any limitation of the seller’s liability for untrue warranties? In the Ziff-Davis case (see CBS Inc. v. Ziff-Davis Publishing Co., 75 NY 2d 496 (1990)) the New York Court of Appeals took the view that what is most important is not whether the buyer considers the warranties to be true. English case law, on the other hand, remains unclear. In Eurocopy plc v. Teesdale (see Eurocopy plc v. Teesdale  B.C.L.C. 1067), it was stated that the buyer may not bring a claim for breach of warranty if it had actual knowledge of the facts disclosed. However, a quite different position was taken in Infiniteland Ltd. V. Artisan Contracting Ltd. (see Infiniteland Ltd and John Steward Aviss v. Artisan Contracting Ltd. And Artisan (UK) plc  E.W.H.C. 955;  All E.R. (D) 350 (Apr.)), where it was held that it is sufficient to prove that (i) the warranty was provided and (ii) the warranty was inaccurate. The negative consequence of a buyer’s awareness of the inaccuracy of a warranty constitutes a major difference between warranties and representations (see T.L. Stark, ‘Another view on reps and warranties’, Business Law Today (Jan./Feb. 2006).
The English Misrepresentation Act 1967 (see Misrepresentation Act 1967, s. 21) provides that where parties enter into a contract after a misrepresentation has been made by one of them to the other, the party accused of misrepresentation will not be liable for any resulting loss suffered by the other party if it can prove that it had reasonable grounds to believe, and until the contract was done actually did believe, that a statement it made was true (see E. McKendrick, supra note 4 at 272-292).
Under Article 557 of the Polish Civil Code, the seller is released from liability for a defect covered by a statutory warranty if the buyer knew about the defect in question, as it is assumed that the buyer agreed to buy the object for an agreed price knowing that it was defective. This provision relates not to what the buyer should have noticed (as a buyer is under no obligation to examine the object sold), but to what the buyer actually knew. The burden of proving such knowledge lies on the seller (I CR 177/72, OSNC 1973, No. 10, item 171). In a decision on 24 October 1972, the Polish Supreme Court addressed the question of whose knowledge is decisive when considering whether a legal entity acted in good or bad faith. It took the view that it is sufficient for the persons who are members of the entity’s governing body to have the required knowledge. If the case is not about a legal transaction, the knowledge of just one person belonging to the governing body is sufficient.
The buyer’s knowledge would not appear to be identical to that of its advisers. The buyer is considered to know what is contained in any oral or written reports that have been prepared, but it is not necessarily aware of the information provided by the seller to the adviser.
Liability under the statutory warranty may be extended or narrowed at the will of the parties, subject to certain exceptions, which include cases of willful misconduct (Article 473 of the Polish Civil Code – art. 473(1): the parties may decide in their contract that the seller bears liability for the non-performance or improper performance of an obligation for which it is not liable under statutory law; art. 473(2) a provision exonerating the seller for damage done intentionally will be null and void) and defects insidiously concealed by the buyer (Article 558(2) of the Polish Civil Code).
3.1. Calculation of damages provided by contract
The method of calculating damages is frequently regulated in the parties’ contract. Highly complex stipulations are common where financial investors are involved. Where industry investors are involved. Where industry investors are involved, the clauses tend to be of a more general nature. Like price adjustment clauses, damages clauses generally refer to standard methods of evaluating businesses (see TL. Copeland, T. Kolle J. Murrin, Valuation, Measuring and Managing the Value of Companies (Warsaw, 1997) at 66ff). The three principal methods are (i) net asset value (NAV), which is the difference between the sum of adjusted assets and all adjusted liabilities; (ii) the use of multiples (most frequently EBITDA – Earnings before Interest, Tax, Depreciation, Amortisation) derived from analyzing trading practices and comparing transactions with peer companies on the given market, local or global; (iii) DCF (Discounted Cash Flow), which presents the current value of a business through a discounted future cash flow predicted on the basis of many factors, such as the company’s present financial position, its financial forecasts, budgets and plans or expected market developments. For acquisitions of companies on regulated markets, valuations also include published price indexes and their fluctuations.
For breaches of warranties relating to specific receivables or liabilities or a list or class of receivables or liabilities, parties commonly agree damages equal to the face value of the receivable or liability. For example, if a warranty confirms that all receivables disclosed in the balance sheet are truthful and accurate and it subsequently transpires that one of them has, for whatever reason, expired, the loss incurred by the buyer will be equal to the face value of the receivable.
When the shares being purchased constitute a fraction of the target’s share capital rather than its entire share capital, the amount of damages will be in proportion to that fraction.
3.2. Calculation of damages based on general provisions of law
3.2.1. Common law approach
The calculation of damages in common law systems depends on the type of action brought by the claimant. For contractual claim, the compensation should restore the conditions or status the buyer would have enjoyed if the warranty had been true (expectation interest). For tortious claims, the compensation should cover the damage the buyer suffered in relying on what it believed to be an accurate representation (reliance interest – see E. McKendrick, supra note 4 at 181ff).
In the case of a sales agreement, if the object sold is defective, the compensation due to the buyer calculated on the basis of expectation interest would be the difference between the market value of the object when free of defects (regardless of its agreed price) and the actual value of the object when free of defects (regardless of its agreed price) and the actual value of the object found to be defective. If calculated on the basis of reliance interest, the compensation would be the difference between the price of the object sold as determined in the agreement (regardless of its market value) and its actual value (ibid. at 404-405). The impact these two methods of calculation would have on the sale of shares may be illustrated by the following example. The buyer of the target/s entire share capital alleges that a representation concerning the target’s financial statements was inaccurate because it omitted a certain liability. At the same time, it is clear that the company has additional assets not mentioned in the financial statements used to evaluate the target. The resulting harm to the buyer for the purpose of a contractual liability claim would be equivalent to the value of the undisclosed liability only. In the case of a tortious claim, any additional assets held by the target but not mentioned in the financial statements will be deducted from the value of the undisclosed liability. The damages would be equal to the resulting balance (see W.J.L. Knight, supra note 17 at 127).
3.2.2. Civil law – the Polish approach
In Polish law, no distinction is made between contractual and tortious liability when it comes to calculating damages.
Compensation for redressable damage is calculated as the difference between the situation at the time of determining the damage and the situation as it would have been if would have been if the loss had not occurred. The difference should be seen from the subjective point of view of the claimant’s interest (pretium singular) and, unless provided otherwise, should not be limited to goods directly affected by the event triggering the loss but be more comprehensive and include lost profits. The evaluation of the situation as it would have existed is likely to be a complex matter given the difficulty of determining the normal consequences of untrue warranties on the buyer’s assets.
Breaches that cause non-pecuniary loss cannot lead to redress as the extent of the damage cannot be assessed using the differential method discussed above. This is also the case under common law (see N. Andrews, M. Clarke, A. Tettenborn, G. Birgo, Contractual Duties; Performance, Breach Termination, and Remedies, (Sweet & Maxwell, 2011) at 429-440). However, it is possible to cover such damage by way of a contractual obligation, or to establish liquidated damages.
The breach of a representation that has no direct impact on the value of the target’s shares may have an impact on the value of other assets held by the buyer. For example the buyer takes out a loan in order to finance the acquisition of shares. The right to discount the share price is subsequently exercised, reducing the price of the shares. In addition to recovering part of the purchase price, the buyer may claim damages equal to the cost (i.e. arrangement or commitment fee) of that part of the loan which would not have been used if the price had been determined properly at the outset.
In light of the principle of the balancing of benefit against loss (see M. Kaliński, Szkoda na mieniu i jej naprawienie (Warsaw, 2008) at 481ff) (compensation lucre cum dammo), if the inaccuracy of one warranty causes the value of the shares to be less than expected, and the inaccuracy of another warranty produces the opposite effect, should the effect of the inaccuracies be considered globally and the damage suffered from one inaccuracy be offset against the gain resulting from the other, or should the damage be assessed for each inaccuracy separately? Scholars and the courts consider that the benefit should be balanced against the loss when they result from the same event. However, if the loss is triggered by one particular warranty rather than the warranties treated as a whole, the principle of balancing benefit against loss would appear to be inapplicable. If the inaccuracy of a representation or a warranty works in the buyer’s favour, this would result in the enrichment of the buyer, leading the seller to claim repayment or a price increase, which would be contrary to the purpose of representations and warranties.
3.3. The effect of the parties’ intentions on the assessment of damage
The harm caused to the buyer’s assets by untrue warranties may prevent the buyer from achieving the goals pursued in undertaking the acquisition. Such goals may include the new synergies expected to result from the operation. Is it important for the seller to know what the buyer’s intentions and expectations were when purchasing the shares? In Poland, legal scholarship (ibid. at 139) considers that the extent of the damage should be determined regardless of whether the buyer’s expectations were foreseeable by the seller. However, the damage should remain a ‘normal’ consequence of the seller’s act, insofar as it should not be interrupted by any incident that cannot be attributed to the seller.
The question of the buyer’s intentions my also work to the benefit of the seller. It is worth mentioning here a UK case where the buyer’s claim for damages was based on a breach of warranties concerning financial statements of the target company as a result of which the value of the company and the effect of the acquisition proved to be worse than could have been expected in light of the buyer’s decision, as the essential purpose of the acquisition of the company was to acquire contracts with two members of the board of the target company rather than the company itself and its wealth (JEB Fasteners v. Mrks, Blom & Co  1 All E.R. 583).
3.4. Evaluation of damages by the arbitral tribunal
3.4.1. Ascertaining entitlement to damages
Arbitrators will first need to determine whether a representation or a warranty has been breached. In contrast to the relatively simple task of ascertaining legal title to assets, or corporate or administrative approval, this may be a difficult exercise. Where the alleged breach concerns untrue financial statements, arbitrators will have to decide whether or not certain facts were properly posted in the balance sheet or the profit and loss account, i.e. in accordance with relevant accounting standards. In such cases, it is likely to be necessary to hear expert witnesses proposed by the parties.
The exercise may be further complicated by the use of ill-defined or equivocal expressions like ‘to the best knowledge of the seller’ or unquantified references to materiality. In William Sindall plc v. Cambridgeshire County (see Levinson v. Farin  2 All E.R. 1149) the court decided that a misrepresentation concerning the value of net assets of a company is material when the missing assets exceed 20% of the total guaranteed assets. ICC Case 10977 provides an example of such semantic difficulties (an extract from this award is published in this issue of the Bulletin, see paragraphs 298-311). Here, in order to ascertain whether or not a warranty had been breached, the arbitral tribunal had to determine the meaning of the expression ‘in the ordinary course of business’.
3.4.2. Calculation of damages
Given the diverse methods of evaluating businesses, there is a strong possibility that the opinions of expert witnesses produced by the parties will diverge. Also, expert witnesses receive their information from one party only, so there is an inevitable risk of bias. When faced with conflicting expert opinions, the tribunal must decide whether it is ready to draw its own conclusions based on the opinions already submitted or needs input from an additional expert appointed jointly by the parties or by the tribunal itself. In certain cases, it will be impossible to quantify the loss suffered by the party with mathematical precision, leaving the tribunal to work within certain ranges rather than determining an exact figure. In such a situation, the arbitral tribunal has the power (as do State courts in many countries) to award what it judges to be an appropriate sum, having regard to all the circumstances of the case (Polish Code of Civil Procedure, Art. 322; German Code of Civil Procedure, § 288).
ICC Case 11593 (an extract from this award is published in this issue of the Bulletin, see paragraph 335) offers an interesting example. In order to determine the value of loss under a material contracts warranty, the proper discount rate had to be established. The arbitrators took into consideration the fact that sophisticated parties were involved. Furthermore, the cash flows as issue in the arbitration were generated from the use of assets to provide services to customers, and did not represent a loan or borrowing as discussed by the parties. In the circumstances, the tribunal found that the appropriate discount rate would be that based on the weighted average cost of capital.
3.4.3. Filling contractual gaps
When parties try to regulate all aspects of their cooperation in their agreement there is a danger that they will leave certain issues unaddressed and unregulated, raising the question of whether the omission was intentional or simply an oversight caused by the process of lengthy and tiring negotiations. In such cases, the arbitrators will be required to clarify the parties’ intentions by way of appropriate interpretation (cf. BGV. § 157; Polish Civil Code, Art. 65).
A problem of this kind arose in ICC Case 14691 (an extract from this award is published in this issue of the Bulletin, see paragraphs 382-406). The arbitral tribunal had to determine the proper US dollar / Brazilian reais rate of exchange for the purpose of calculating an advance on the earn-out. The parties had not touched on this issue, probably because the idea of an advance was raised later in the negotiations. After hearing expert witnesses called by the parties, the arbitral tribunal made the final decision by interpreting the contractual langue in the context of the transaction.