Warranty and Indemnity insurance

Donald Dinnie, Norton Rose Fulbright

Insurers and intermediaries involved  in providing warranty and  indemnity insurance will be interested in this recent judgment dealing with contractual warranties and an indemnity of EBS International (Pty) Limited and  another v Shaun Edward Wright and which is relevant to any subrogated recovery.

The seller had represented that its tax affairs were in order. Those representations were underpinned by way of warranties with an indemnification to make good any liabilities, costs expenses or damages suffered as a result of the breach of the warranties in the agreement of sale.

It was subsequently determined that the seller had significantly understated its tax liabilities and the buyer  claimed against the  sole shareholder and sole director of the seller alleging that he had breached his fiduciary duties in significantly understating the tax liability of the seller to the tax authorities.

The court said that compliance with the tax laws as a non-negotiable imperative for any business and that the shareholder and director was fully aware that it was imperative for the seller to be a law-abiding taxpayer.  That is precisely why the warranties and indemnities were negotiated in the sale agreement.

On the evidence, the tax assessments established that over a long period the director shareholder failed to ensure that the seller complied with its tax obligations.

The particulars of the tax assessment also demonstrated a possible breach of the fiduciary duties owed to the seller by its director who had mined the profits from the seller by declaring and paying himself dividends on an annual basis.

Where a breach of a warranty has been indemnified, the injured parties’ claim under the indemnity is not based on the breach of the warranty but on the indemnity clause itself.

The shareholder director had furnished warranties and indemnities to the buyer to the extent that he would make good any undisclosed tax liabilities that came to light after the conclusion of the sale agreement including the cost consequent upon the institution of a claim for a breach of the warranty set out in the agreement of sale.

The fiduciary duty damages which may have been suffered by the seller and which may in turn be recoverable from the shareholder director are an entirely discrete issue and essentially a pure damages claim. It is a claim in its own right and is neither an action based in delict nor on fault.  The claimant must be placed in the position it would have been if there had been no breach of the fiduciary duty.

By virtue of the provisions of the appropriate tax legislation, the particulars of an assessment raised by the tax authorities are deemed to be correct.  So once an assessment is raised by the authorities they are deemed to be conclusive against the person assessed subject to the relevant proviso.

It was common cause that the warranties were breached and the indemnities that were tendered were triggered.

The question arose whether the claim by the buyer as a direct result of the breach of warranties was a claim for specific performance in the circumstances.

The fiduciary duties breached by the shareholder director, if any, were fiduciary duties that he owed to the seller and not to the buyer.  Any fiduciary duty claim is in the strict sense by its very nature a damages claim and does not fall to be determined by way of motion proceedings.

However the court held that the particulars of the tax assessments in connection with the indemnity claim amount to conclusive evidence that the shareholder director breached the contractual warranties and that in turn triggered his obligation to make good on his indemnity.  An indemnity is a contractual agreement between two parties where one agrees to pay for potential losses or damages claimed by a third party.

The court said that the buyer had met the requirements for a claim for specific performance given the contractual obligations in the written sale agreement with the shareholder director.

That was because the terms of the agreement were not in dispute, the buyer had demonstrated compliance with its reciprocal obligations in terms of the agreement of sale, it had demonstrated non-performance by the shareholder director, and the buyer had accordingly elected to claim, as it was entitled to do, specific performance.

First published by: Financial Institutions Legal Snapshot