Losing the longstop: High Court decision highlights importance of clearly drafted longstop clauses
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In Damoco (Bermuda) Ltd and Others v Atlanta Bidco Ltd,1 the High Court rejected claims as to the longstop date for accounts needed to calculate a contractual payment. Instead, the Court adopted a much narrower interpretation of the longstop provision, highlighting the importance of clear and unambiguous drafting.
The Claimants ("Damoco") agreed to sell shares in their subsidiary (the "Target") to the Defendant ("Atlanta"). They recorded their agreement in a sale and purchase agreement dated 5 July 2018 ("SPA").
The SPA included deferred consideration provisions. If the Target group's 2019 EBITDA met certain criteria, the SPA required Atlanta to pay Damoco EUR 20 million in deferred consideration.
The SPA contained a procedure for assessing whether EBITDA met the deferred consideration criteria. This included a longstop provision requiring Atlanta to:
… deliver to [Damoco] a draft of the Deferred Consideration Accounts … within 30 days after the date upon which the audited financial statements of the [Target] which relate to the Deferred Consideration Period are in such condition as could be formally signed off by the Auditors and in any case no later than 30 June 2019. (emphasis added)
Atlanta failed to provide the draft Deferred Consideration Accounts by 30 June 2019. Instead, it sent draft accounts to Damoco on 5 August 2019 (the "5 August accounts"). Atlanta called these "draft Deferred Consideration Accounts", but also emphasised that they were unaudited, and subject to further review, adjustment and board approval. Atlanta's position was that the SPA required it to deliver draft Deferred Consideration Accounts by 30 June 2019 only if the Target's audit was complete by that date (which it was not).
In response, Damoco purported to accept Atlanta's 5 August accounts as the "draft Deferred Consideration Accounts" required under the SPA. The SPA provided that once the draft Deferred Consideration Accounts were accepted, they were final and binding. Since the relevant EBITDA criteria were met, Damoco demanded EUR 20 million from Atlanta in deferred consideration.
When Atlanta failed to pay, Damoco started English Court proceedings and sought summary judgment.
The main issue for the Court was whether Atlanta's 5 August accounts amounted to "draft Deferred Consideration Accounts" under the SPA.2 This required, in particular, analysis of the SPA's longstop provision for delivering the accounts (as excerpted above).
Mrs Justice Moulder refused Damoco's summary judgment application. She held that the 5 August accounts were not "draft Deferred Consideration Accounts" under the SPA. On a proper construction, the SPA's longstop provision required draft Deferred Consideration Accounts to be delivered by 30 June 2019 only if they were ready for auditor sign-off by that date. That was not the case here, so the 30 June 2019 longstop date did not apply.
In reaching this conclusion, Moulder J found that:
- The objective meaning of the longstop provision, read alone, was ambiguous. Nonetheless, Moulder J inferred that the "starting point for the preparation of Deferred Consideration Accounts was that the financial statements are in almost final form".3 She rejected Damoco's argument that the longstop provision was only about the timing of the delivery of the accounts and not whether the accounts needed to be audited. She concluded that "if the meaning of [the clause] was to state that the draft accounts were to be provided in any event by 30 June, regardless of the point which had been reached in relation to the audited accounts, this could have been done in simpler language".4
- Other provisions in the SPA suggested that an audit had to precede delivery of the Deferred Consideration Accounts. The SPA's definition of EBITDA referred to "audited" Deferred Consideration Accounts. The SPA also required the Target to use Deloitte LLP as its auditors. Moulder J concluded that, read together, the "whole tenor" of the SPA's deferred consideration provisions was "that the auditors played an important role in the preparation and determination of financial statements for the purposes of calculated Deferred Consideration".5
- The factual background at the time of the SPA supported this interpretation. In particular, the SPA's 30 June 2019 longstop date appeared to be based on the length of time it took to prepare accounts in the previous year, and so failed to allow for any unforeseen delays (as occurred here). Moulder J also noted that the SPA was drafted by sophisticated commercial parties. References in the SPA to "audited" accounts should therefore be given legal significance, rather than viewed as a "convenient but non binding option".6
- The commercial context of the SPA also supported this result. Audited accounts provided protection for Damoco, as they prevented Atlanta from manipulating financial statements to avoid paying deferred consideration. It was "contrary to commercial common sense" that Damoco would wish to give up this protection at a 30 June "cut off date".7 The audit requirement also protected Atlanta from accounting manipulation by any management sellers at the Target who remained in post, and who stood to receive a share of any deferred consideration.
Accordingly, Moulder J found that, properly construed, "the obligation to provide the draft Deferred Consideration Accounts was within 30 days after the accounts were at the point at which they could be signed off by the Auditors (except where that date fell within the 30 day period immediately prior to 30 June)".8
This decision highlights the importance of clear drafting in relation to any pre-conditions that apply to a longstop date. It also demonstrates how the drafting of contractual provisions will be construed in the context of the contract as a whole, and its commercial context. In order to ensure certainty with respect to the application of a longstop date, as Moulder J alluded to, parties should use simple and unqualified language. Linguistic complexity gives rise to ambiguity, and ambiguity always leaves open the possibility of longstop provisions working in ways that parties may not expect – and may not welcome.
1 Damoco (Bermuda) Ltd & Ors V Atlanta Bidco Ltd  EWHC 501 (Comm).
2 Issues also arose as to whether Damoco properly authorised its 8 August 2019 acceptance of the 5 August accounts, and as to whether the proceedings had been commenced with the authority of the First Claimant in circumstances where it was in liquidation. This alert does not address these issues further.
3 At paragraph 43.
4 At paragraph 46.
5 At paragraph 48.
6 At paragraph 53.
7 At paragraphs 58-60.
8 At paragraph 61.
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