Lessons from a £5.2m breach of warranty claim in a business sale

Background facts

In October 2021, Learning Curve Group (“LCG”) bought the entire share capital of APCymru Limited (trading as MPCT) from founder Richard “Huw” Lewis and his partner Melanie Probert for just over £16.8m. MPCT delivers military preparation training to young people, with funding in England coming directly from the Education and Skills Funding Agency and in Wales via subcontract.

The purchase price was based on a maintainable EBITDA of £2.571m, multiplied by 5.5. No further earn out became payable.

Within a year, ESFA audited MPCT’s English operations for the 2020 to 2021 academic year. The audit found breaches of the funding rules, leading to an overclaim of £1.247m, and the Company was required to repay £783,325 (Clawback). This overlciam arose from:

1. Planned hours over claim – students were recorded as taking full Diplomas when many only took shorter courses, inflating funded hours.

2. Condition of funding breach – some full time students with a grade 3 in maths or English who should have been on GCSE courses were recorded as part time and given Functional Skills instead, avoiding a compliance penalty.

Following negotiation, the clawback was reduced to £783,325, which the sellers later paid under a specific indemnity in the share purchase agreement. However, LCG also brought a separate breach of warranty claim, arguing the issues had much wider and longer-lasting impact on MPCT’s value, requiring operational changes, reducing future funding, and causing a fall in EBITDA.

The sellers denied breach, argued any claim was time-barred under the SPA, and said the indemnity payment was the buyer’s sole remedy.

The court’s decision

The High Court ruled firmly in favour of LCG, awarding £5.21m in damages for breach of warranty under the SPA. This was significantly more than the £783,325 the sellers had already paid under the specific indemnity for the ESFA clawback.

What the warranties said

The SPA contained a suite of warranties from both sellers, including that:

• MPCT had complied, and continued to comply, in all material respects with the ESFA funding rules.

• Since the accounts date (31 July 2021) there had been no material adverse change in the company’s financial or trading position, nor any fact likely to cause such a change.

• The company was entitled to receive all funding due under contracts with the ESFA and others.

• The company had complied with all applicable laws and regulations binding on it.

Some of these were “absolute” warranties (a promise that a fact is true), others were “knowledge-based” (only warranting the fact so far as the sellers were aware, after due enquiry). LCG argued that the key funding compliance warranty was absolute — the sellers said it was knowledge-based. The judge agreed with LCG that the compliance warranty was not limited to the sellers’ knowledge and that the breaches found by the ESFA were enough to establish breach.

The buyer’s knowledge point

A common seller defence is that the buyer already knew about the problem before signing, so cannot complain later. The SPA here had a clause excluding liability where the buyer had “actual knowledge and awareness” of the facts giving rise to the claim. The sellers argued that LCG’s due diligence, and documents in the online data room, showed the funding compliance issues — or at least the risk of them.

The court disagreed. The due diligence material did not reveal the systematic breaches later found in the audit. While LCG knew there could be some risk in ESFA-funded provision (a fairly generic point in the sector), it had not been told of the practices that inflated planned hours or misclassified students to avoid the GCSE requirement. Importantly, the sellers could not point to any disclosure that clearly set out these breaches, so the buyer’s knowledge exclusion did not apply.

Why the warranty claim exceeded the indemnity claim

Usually, an indemnity is considered more “buyer-friendly” than a warranty because it allows recovery of all loss flowing from the event, without having to prove breach, foreseeability or certain causation hurdles. In many deals, an indemnity will produce a higher recovery than a warranty.

Here, however, the indemnity was drafted narrowly — it only covered the specific ESFA clawback for AY20/21, which was £783,325. It did not cover:

• knock-on reductions in ESFA funding in later years;

• the cost of operational changes needed to comply with the funding rules;

• the adverse effect on MPCT’s maintainable earnings and, therefore, on its capital value at completion.

The warranty claim, by contrast, was based on the principle that the buyer should be put in the position it would have been in had the warranties been true. This meant valuing the company at completion on the basis that it was fully compliant, then comparing that to the actual value given the breaches. The judge accepted expert evidence that the breaches reduced the company’s maintainable EBITDA and applied the purchase multiple to arrive at a loss of £5.21m.

LCG could not recover under both routes for the same loss — the SPA had a “no double recovery” clause — so it had to elect between the indemnity claim and the warranty claim. Unsurprisingly, it chose the much higher warranty damages.

What this means if you are buying or selling a business

This case underlines several important points for both buyers and sellers when negotiating and drafting a business sale agreement.

1. Warranties and indemnities do different jobs

• Warranties are statements of fact about the business at completion. If they are untrue, the buyer can claim damages based on the difference between what it paid and the true value of the company on the day. That means a breach can lead to a claim for diminution in value, even if the immediate loss looks small.

• Indemnities are promises to reimburse the buyer for a specific liability if it arises. They are usually “pound-for-pound” cover, but only for the risk described. If the indemnity is narrowly defined, it will not cover knock-on or longer-term effects unless the wording expressly includes them.

In this case, the indemnity covered only the ESFA clawback for one academic year. The warranties, however, covered wider funding compliance. That allowed the buyer to recover for the broader, longer-term reduction in the company’s value.

Lesson: For buyers, use warranties to protect against systemic or undiscovered risks, and make sure indemnities are drafted widely enough to capture all foreseeable consequences of a known issue. For sellers, ensure indemnities are tightly defined to prevent them from becoming an open-ended route to damages.

2. The buyer’s knowledge exclusion needs clear drafting and disclosure

Many SPAs include a clause that prevents the buyer from claiming for a matter it knew about before completion. The protection this gives to the seller depends entirely on:

• The wording of the exclusion – Is “knowledge” defined? Does it mean actual knowledge of named individuals? Does it include what the buyer ought reasonably to have known?

• How the matter is disclosed – Was it set out in the disclosure letter? Is it clearly identifiable from the data room? Would it be obvious to a reasonable buyer that the disclosed facts amount to a breach?

Here, the sellers could not rely on the exclusion because the breaches had not been specifically disclosed. General sector risks or vague references in due diligence were not enough.

Lesson: For sellers, if you want to rely on a knowledge exclusion, ensure the issue is disclosed clearly and in writing. For buyers, resist wide definitions of “knowledge” and make sure the clause only captures what was truly and expressly known.

3. Double recovery clauses force a choice

This SPA had a “no double recovery” provision, meaning the buyer could not recover under both the warranty and indemnity for the same issue. That’s standard, but it meant LCG had to choose the larger of the two routes.

Lesson: Buyers should check whether the indemnity is drafted so narrowly that the warranty claim might end up being more valuable, and negotiate accordingly. Sellers should recognise that a narrow indemnity might still leave them open to a much larger warranty claim.

4. Regulatory compliance risks can be value risks

Breaches of funding rules, licences or sector-specific regulations can have impacts far beyond the immediate penalty. In this case, the funding breaches cut into MPCT’s maintainable earnings for future years, directly lowering its value at the point of sale.

Lesson: Buyers in regulated sectors should factor future knock-on effects into valuation and due diligence. Sellers should consider whether any historic compliance issues might give rise to warranty claims down the line, and disclose them fully.