Liability caps are usually negotiated. Whether that be in commercial contracts, share purchase agreements or any contractual relationship where liability is created. A recent case, Equitix EEEF Biomass 2 Ltd v Fox  EWHC, shows how the specific wording in liability caps is particularly important. The issue here concerned whether or not ancillary liabilities, such as litigation costs and interest on damages, were deemed capped.
The facts of this case are complicated, relevant and perhaps prescient. The legal side more common. A company had been sold and a share purchase agreement signed. The share purchase agreement detailed a number of warranties. Many of which proved to be false. The court awarded a maximum of £11 million for damages to the claimant, hitting the liability cap. The court went on to award more for ancillary liabilities, including litigation costs and interest on damages and costs. It was this second award which concerned the importance of wording in liability caps.
Cleaner energy – what happened?
Gaia Heat Limited entered a contract with Greenenergy Biofuels Limited to supply heat energy by burning biomass to produce steam. The biomass would consist of recycled wood fuel. The environmental logic being that the amount of carbon dioxide absorbed by the trees felled to produce the wood acts as an offset to the amount of carbon dioxide released when producing energy. It also makes use of recyclable wood or wood that would otherwise be wasted in timber harvest operations.
To achieve this Gaia purchased two biomass boilers from an Italian company called Uniconfort srl. These needed to comply with the Waste Incineration Directive and nitrogen oxide legislation limits. Gaia also relied upon Greenenergy to supply feedwater, which was required not to be too ‘hard’ and its ‘direct conductivity’ was required to meet certain technical specifications. Alongside relying upon their contractors, Gaia needed to comply with an array of regulations themselves. Most importantly, the boilers were regulated by a permit issued by the Environmental Agency in May 2014 under the Environmental Permitting (England and Wales) Regulations 2010. One such regulation stated that recycled wood fuel could only be feed into the boiler once a temperature of 850 degrees C was reached. This initial temperature would be reached by supplementary oil-firing.
Liability caps – share purchase agreement
Gaia then entered negotiations with Equitix with the view of selling the business and their sole contract with Greenenergy. It was this share purchase agreement which would go on to highlight the importance of the wording in liability caps. The agreement was negotiated and re-negotiated over many months, with Gaia producing financial models based on steam output and ensuring that the boilers were legally compliant. Eventually a much revised, and less valuable, agreement was signed with £2 million placed in an Escrow account, pending the outcome of performance testing.
Warranties and disclosed matters
Detailed warranties relating to Gaia’s business and assets were set out in the share purchase agreement. These concerned:
- The condition, repair and capability of the plant and equipment.
- Compliance with the environmental permit.
- The reasonableness of the projections and forecasts in the financial model.
- The status of Gaia’s contract with Greenenergy.
These warranties were given as at the completion date ‘subject to the disclosed matters’. These disclosed matters would be found either in the share purchase agreement or disclosure letter. Disclosure letters are key documents in any acquisition of shares in a company. The letter is prepared by the seller and includes general and specific disclosures regarding the seller’s warranties in the share purchase agreement.
Therefore, the sellers’ liability for breach of warranty included a limitation (sometimes known as a ‘knowledge limitation’) which stated: ‘the buyer shall not be entitled to bring a claim and the sellers shall have no liability to the buyer where the facts and circumstances giving rise to the claim are within the actual knowledge of the buyer’.
With regard to liability caps, the limitations on Gaia’s liability for warranty claims also included:
- A cap on liability for warranty claims which limited Gaia’s aggregate financial exposure to £11 million.
- A clause ensuring Equitix took ‘all reasonable action to mitigate any loss suffered by Equitix or Gaia which would, could or might result in a claim… against the sellers.’
Breach of warranties
Compensatory damages for breach of a warranty of quality in a share purchase agreement compare the actual position the claimant is in and the position it would have been in without the breach. Therefore, the usual measure of damages is the difference between the value of the shares as warranted, meaning if the warranties had been true, and the actual value of the shares.
From early 2015 Gaia’s biomass boilers experienced a number of stoppages and low performance standards, which lead to difficulties in properly performing the Greenenergy contract. Significantly the boiler struggled to maintain a temperature of 850 degrees Celsius meaning it was not legally allowed to burn its supply of biomass. It was found that emissions were often beyond the limits of the environmental agency’s permit. The boilers’ condition was poor and not capable of producing anything like the amount of energy purported by projections made in the financial model. Poor quality feed water and high levels of dissolved solids to counteract it had led to the build-up of scaling which impaired the boilers’ performance.
The court held the warranted value of the shares being £14.45 million, i.e. as suggested by the documentation, price and information passed to Equitix. However, it considered the true value of the shares to be £1 million. Therefore, the buyer’s loss in respect of breach of warranties was £13.45 million. This loss was capped by the £11 million liability cap found in Schedule 5 of the share purchase agreement. Therefore, the defendants were entitled to a £11 million claim for breach of warranties.
This is where the wording of liability caps became significant. The cap in this case was expressed as applying to liability “in respect of” any claim under the share purchase agreement for breach of warranty. The sellers and defendants therefore claimed that “in respect of” should be interpreted widely enough to include the interest on damages, costs (i.e. litigation costs) and the interest on costs. It was argued that those ancillary (extra) costs should not be uncapped and therefore the claimants would only be entitled to the £11 million for damages.
Liability caps – judgement
The court found in Equitix’s, the buyer’s, favour when it came to the interpretation of liability caps. Therefore, the meaning of “in respect of” was not wide enough to include ancillary costs such as interest on damages or costs under the cap. Consequently, the claimant was entitled to recover these ancillary costs in addition to the £11 million for the damages for breach of warranties. One piece of logic used to reach this conclusion was that these ancillary costs went beyond the liability under the share purchase agreement and were within the court’s jurisdiction. Additionally, the liability cap wording did not specifically address these ancillary costs but simply stated that it applied to liability “in respect of” of any claim under the agreement for breach of warranty. The court judged that if the defendants wished to cap liability for these ancillary costs, they should have explicitly stated so.
Here to help
When looking to make sure liability caps are worded correctly, as shown by the case above, you will need to be as explicit as possible. The courts held that “in respect of” was not as wide as the phrase “arising out of or in connection with”, but even so this other phrase is still open to subjective interpretation and so should be avoided. Liability caps will often be negotiated and can, if a contractual relationship goes to court, end up being one of, if not the most, important clauses in the contract. This case was clearly a catastrophic failure for the sellers, with the claimants being entitled to the full amount under the cap. But the cap still reduced the claim by £2.45 million.
I started this blog by suggesting that in some way or another this case may prove to be prescient. This being because, with the move to greener energy, companies are incentivised to invest and make viable other energy sources. Along the way there are likely to be contractual disputes, especially when you consider the efficiency and effectiveness of extracting energy from fossil fuels. One of the main issues Gaia faced was competing with a nearby fossil fuel burning energy supplier. This meant they were outcompeted and, in some instances, made to change the temperature of the boiler when reacting to demand. This changing of temperature made it hard for the boilers to be properly maintained. That is not to say that Gaia didn’t cause their own problems. They certainly did. But with the transition from one energy form to another, it is likely that more disputes will arise where energy suppliers are unable to fit neatly into the traditional system.