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Indemnity claims and implied terms of accuracy

The High Court has considered whether indemnity claims are subject to an implied term of being “accurately calculated and based on factual substance” in the case of Bir Holdings Limited v Mehta [2014] EWHC 3903 (Ch), a case which highlights to importance of expressly including provisions governing the mechanism for claims made under an indemnity within a contract.

Bir Holdings Limited concerns the sale of shares in a company. Although the dispute relates to warranties and indemnities given in the contract for the sale of the shares, unusually the claimants were the sellers and the defendants were the buyers. Under the contract, part of the consideration was payable into a “Retention Account” held by the defendants’ solicitors who acted as the “Retention Agent”. If the Retention Agent was notified of a “Relevant Claim” (broadly, a claim under the warranties or indemnities) before a certain date, they were to pay the amount of that claim to the defendants. The effect of this was that any amount stated to be due by the defendants would be paid to them without enquiry as to the merits of such a claim or any opportunity for the claimants to object. The contract itself did not provide any mechanism for the determination of any disputes or what would happen if it turned out that the claims made by the defendants were unfounded.

The defendants put forward six claims under the contract, and the defendants’ solicitors paid out the value of the claim from the Retention Account. The claimants claimed that only a small amount of the claims were justified, and sought repayment of the remainder. The claimants argued that there was an implied term in the contract that any Relevant Claim would be “accurately calculated and based on factual substance”, and to the extent that the claims put forward were inaccurate or not supported by facts, the amount taken from the Retention Account was recoverable. Alternatively, they claimed that the defendants had been justly enriched by the amounts paid to them.

The High Court judge held that such a term could not be implied. Where interpretation of a contract involves putting into the contract wording, or even a whole clause, which it did not originally contain, the judge held that it is appropriate to approach the question by asking whether an objective observer would conclude that the parties must have intended that wording to be included in order for the contract to make commercial sense. The court has no power to improve the bargain that the parties actually made, so the wording to be added must be the minimum necessary to make the contract commercially sensible.  The judge held that, in this case, the structure of the Retention Account was obviously intended to be favourable to the defendants by allowing them to deduct amounts from the Retention Account without having to justify the deduction to the claimants in advance or seek their consent. The judge held that it would be inconsistent with this commercially advantageous position to imply an obligation on the defendants to prove that the claims they put forward were accurately calculated and supported by the facts.

This case demonstrates the importance of careful drafting when constructing indemnities, retention accounts and the manner under which claims are brought and settled. For instance, if the seller intends that full grounds for any claim, along with evidence in support, should be provided when making a claim, it is advisable to include this in the contract. Furthermore, if a seller intends that no money should be payable from a retention account without their consent, this should also be expressly provided for in the contract.

Note that the judge held that the alternative plea of unjust enrichment was appropriate, and the retention of funds by the defendant would be unjust if the claimants could show that the claim was unjustified or the defendant withdrew or abandoned that claim. In relation to the first of these alternatives, the onus would be on the claimant to show that such claims are either not properly made (e.g. that there was no breach of the warranty alleged) or are excessive in amount.

For more information, please contact the corporate team.