Accurate drafting of tax warranties and indemnities: Nuts and Bolts
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Key points

  • A mergers and acquisition document will extend beyond the transaction concerned
  • The importance of contractual drafting was highlighted in the Minera Las Bambas case
  • The contracts were governed by English law
  • An indemnity against the full amount of adversely determined tax matters
  • The sellers argued that tax became payable only when an enforceable obligation arose
  • Generic drafting will not cater for all scenarios.
  • The Minera case demonstrates the importance of due diligence on transactions
  • Tax advisers should work closely with lawyers to take account of the relevant tax regime
  • The negotiation of mergers and acquisitions (M&A) transaction documents can often include detailed discussions on the technical drafting of particular provisions. Although the nuts and bolts of the underlying concerns may be technical, in practice those drafting discussions are often extremely important and the precise words used (or not used) can be critical

In the heat of negotiations it can be forgotten that the document has a life beyond signing and closing the transaction concerned; for instance, if pre-closing issues come to light some years later. Whether the documentation provides the purchaser with appropriate protection and effective recourse against the seller will turn on the drafting of the relevant provisions.

The importance of contractual drafting was highlighted by the Court of Appeal in Minera Las Bambas SA and another company v Glencore Queensland Ltd and other companies [2019] EWCA Civ 972.

The facts

The facts of Minera can be summarised as follows:

  • The Las Bambas project is a large development to construct and operate copper mines in the Apurimac region of Peru.
  • At the time of the share purchase in question, the project was owned by a Peruvian company, Xstrata Peru SA (“Xstrata Peru”) through a wholly owned subsidiary, Xstrata Las Bambas SA (“Xstrata Las Bambas”)
  • The owners of Xstrata Peru and the purchaser entered into a share purchase agreement on 13 April 2014 under which all the issued shares in Xstrata Peru were acquired by the purchaser from the sellers
  • During the development and construction phase of the project, land belonging to a rural community had been acquired in exchange for building a new town for them in a location away from the project site. The new town came into existence on 27 June 2014
  • Closing under the share purchase agreement took place on 31 July 2014 with the overall price paid for the shares being about US$7bn
  • On 31 December 2014, the purchaser and Xstrata Peru were absorbed by merger into Xstrata Las Bambas, subsequently renamed Minera Las Bambas SA (“Minera”). After the merger, Minera was not only the operating company for the project but also the corporate successor of each of Xstrata Peru and the purchaser
  • After closing under the agreement, the Peruvian tax authority (“SUNAT”) conducted audits which led ultimately to it issuing a tax assessment resolution dated 29 January 2016. The assessment showed that Minera had incurred a liability to pay Peruvian VAT in a principal sum of PEN 28,400,661 (about £6.3m) on 27 June 2014 when the new town came into existence (the new town VAT)
  • SUNAT also charged penalties and interest as a result of Minera’s late payment of the new town VAT which totalled PEN 15,875,970 (about £3.5m) at the time of the assessment
  • As well as the new town VAT, the assessment rejected some VAT credits previously claimed by Minera
  • The assessment was appealed to both SUNAT itself (SUNAT resolved this appeal in December 2016 confirming its determinations) and the Peruvian tax court (such appeal not yet being determined). From the tax court, further appeals in principle lie to higher Peruvian courts
  • Among other things, clause 10 of the share purchase agreement provides: ‘The sellers shall indemnify the purchasers in relation to, and covenant to pay the purchasers an amount equal to … the amount of any tax payable by a group company to the extent the tax has not been discharged or paid on or prior to the effective time and it … relates to any period, or part period, up to and including closing.’
  • The Court of Appeal judgment notes that the definition of ‘tax’ in the share purchase agreement was very wide and covers all forms of taxation, including Peruvian VAT as well as penalties and interest, and that the ‘effective time’ was defined as that immediately before closing (which, as noted, took place on 31 July 2014)
  • Further, under clause 3.1 of a separate deed of indemnity, the sellers undertook ‘to indemnify the purchasers against the full amount (if any) payable by the purchasers’ group under each of the assumed tax matters (if adversely determined)’. The Court of Appeal judgment notes that the ‘assumed tax matters’ would include the new town VAT
  • At this point, readers may be wondering what this has to do with the UK and the Court of Appeal. However, the judgment explains: ‘Although the relevant transactions and their subject matter have no other connection with this country, the contracts are, through the parties’ choice, governed by English law and provide for disputes to be decided in the courts of England and Wales.’

The decision thereby provides some lessons for UK advisers.

The dispute

Among other issues in dispute between the parties, the Court of Appeal was asked to consider whether the new town VAT had become ‘payable’ within the meaning of clause 10.1.1 of the share purchase agreement and clause 3.1 of the deed of indemnity such that a valid claim had arisen.

By way of background, it was found in the High Court proceedings (on the basis of expert evidence) that under Peruvian law an assessment resolution issued by SUNAT establishes a tax liability, such liability being an actual and not merely contingent liability and remains an actual liability until and unless there is a decision of the tax court which sets it aside. However, the liability is not enforceable in that the tax cannot be collected through any coercive procedure while the assessment is under appeal to the tax court. In other words, under Peruvian law an assessment issued by SUNAT only becomes enforceable when the time allowed for filing an appeal expires, if no appeal has been filed within that time. If an appeal is filed, the tax liability cannot be enforced until after this has been determined (and then only if and in so far as the appeal is unsuccessful).

In Minera, the purchaser argued that tax becomes ‘payable’ within the meaning of the transaction documentation (so triggering the sellers’ indemnification obligations thereunder) when the existence and amount of a liability is established; in other words, when an assessment resolution has been issued by SUNAT.

The sellers argued that tax becomes ‘payable’ only when an enforceable obligation to pay the relevant amount arises which, under Peruvian law, will not occur before the appeal to the tax court has been decided.

The High Court had agreed with the sellers’ interpretation of ‘payable’ and the purchaser appealed this aspect of the decision.

Decision

In the Court of Appeal, Leggatt LJ delivered the lead judgment (with which Vos C and Longmore LJ agreed).

Before addressing the question in hand, Leggatt LJ set out the general principles of English law applicable to contractual interpretation, as most recently summarised by the Supreme Court in Wood v Capita Insurance Services Ltd [2017] UKSC 24. In short, the court’s role is to determine the objective meaning of the relevant contractual language. This requires the court to consider the ordinary meaning of the words used in the context of the contract as a whole and any relevant factual background. If there are rival interpretations, the court should consider their commercial consequences and which interpretation is more consistent with business common sense, with the relative weight given to those factors depending on the circumstances.

Leggatt LJ noted that, as a general rule, it may be appropriate to place more emphasis on textual analysis when interpreting a detailed and professionally drafted contract (such as here), and to pay more regard to context if the contract is brief, informal and drafted without skilled professional assistance. Notwithstanding, Leggatt LJ continued that even in the case of a detailed and professionally drafted contract there may not be a clear and coherent text and considerations of context and commercial common sense may take on greater importance.

Turning to the facts at hand, Leggatt LJ observed that the word ‘payable’ is not a legal term of art; it is a word capable of bearing different meanings in different contexts. Accordingly, previous cases showing how the word was interpreted in other documents and contexts were of no assistance; every document must be construed in accordance with its particular terms and in its unique setting. Further, Leggatt LJ stated that he did not consider that in this case any assistance could be derived from examining how the word ‘payable’ was used elsewhere in the share purchase agreement.

Although Leggatt LJ accepted that, as a matter of ordinary language, ‘payable’ is capable of being used in either of the two ways advanced by the parties, in the context here, he found that it is reasonably understood to mean there is an enforceable obligation to pay an amount of tax and not merely that a liability to pay an amount of tax has been established. Leggatt LJ came to that conclusion for two main reasons:

  1. The obligation imposed by the relevant provisions was one of indemnity. In English law an indemnity is a promise to prevent the indemnified person from suffering loss. If the existence and amount of a debt have been established but the indemnified person has not yet come under an enforceable obligation to pay the debt, in Leggatt LJ’s view, it cannot be said that any loss has been suffered which the indemnifier has failed to prevent or to hold the indemnified person harmless against. To this end, Leggatt LJ held that to treat the sellers’ obligation to pay an amount of money to the purchasers as triggered in such a situation would be inconsistent with the general nature and purpose of an indemnity.
  2. It did not make commercial sense to require the sellers to pay an amount of money to the purchasers which is not at present needed, and may never be needed, to satisfy a tax liability. Accordingly, with respect to the new town VAT, were the appeal to the tax court to be successful and the assessment set aside, then (assuming no further appeal) the company would never come under an enforceable obligation to pay the amount claimed by SUNAT. As such, Leggatt LJ held that it would be commercially unreasonable to interpret the documentation as requiring the sellers to put the purchasers in funds for an amount of money that they may (or may not) come under an enforceable obligation to pay in the future. Leggatt LJ further observed that if the intention were to oblige the sellers to provide what would, in substance, be security for a potential future payment obligation, rather than simply to prevent the purchasers from being left out of pocket through being compelled to make a payment, he would expect to find clear and direct language establishing such an arrangement.

On this basis, Leggatt LJ held that the High Court was correct in finding that the new town VAT was not ‘payable’ within the meaning of the contractual provisions, and that it would only become payable if and to the extent that the Peruvian tax court confirmed that Minera was liable to pay this to SUNAT and the debt becomes ‘coercively’ enforceable under Peruvian law.

Implications

The Minera decision is likely to be of interest to any practitioner involved in M&A transactions or tax indemnification arrangements (including tax insurance policies).

The court’s decision is perhaps understandable given the particular drafting of the transaction documents. As a matter of English law, it is difficult to see why any person should be liable under an indemnity when the indemnified person has not (yet) suffered any loss. In this regard, it is difficult to argue against Leggatt LJ’s view that if payment is required under an indemnity before loss has actually been suffered then there should be clear wording to that effect in the document. However, the drafting in Minera is peculiar in that it contains both an indemnity (so importing the wider common law principles described above) as well as a covenant to pay. Had the drafting only included a covenant to pay then questions concerning the purchasers’ loss would not be so relevant although, of course, the key question as to whether the covenant to pay would be enforceable by the time the tax becomes payable would remain.

Although purchasers may request wording asking to receive payment before any loss has actually been suffered, this would probably be resisted by sellers because they would suffer the cash-flow cost and assume the credit risk of the purchaser if they were to make a payment only for any appeal to be successful. Of course, parties may be able to find a compromise if the legal regime concerned has similar payment deferral characteristics to Peru or there are other nuances in the tax system concerned; for instance, an obligation to pay the liability concerned in order to appeal any decision to the courts. Such drafting (if agreed) is not only relevant to the timing of payment provisions, but also the definitions used and the notification and conduct provisions in the transaction documents as well as how those provisions interact with any limitations.

The case highlights the importance of clear drafting in transaction documentation, with issues specific to the relevant jurisdiction being addressed up front through specific and targeted drafting. As the purchaser found in Minera, generic drafting will not cater for all scenarios. As Leggatt LJ observed: ‘Within very wide limits, English law leaves the parties free to make their own bargain and affords them the respect, when they have entered into a formal, professionally drafted and commercially negotiated agreement, of treating them as having meant what they said.’

Conclusion

Although the Minera decision came down to judicial interpretation of contractual provisions, this was based on the findings of fact concerning the operation of the Peruvian VAT system – and when a taxpayer may actually be forced by SUNAT to pay an assessed tax liability. In this regard, Minera demonstrates the importance of the tax advisers undertaking the due diligence on the transaction working closely with the lawyers drafting the transaction documents to ensure that they cater appropriately for the risks and nuances of the tax regime in the jurisdiction(s) concerned.

This article was originally published on Taxation.co.uk on 9 September 2019 and can be accessed here.