Triumph: Preparation of forward looking projections

On 11 March 2019, the High Court delivered judgment in the case of Triumph Controls – v – UK Ltd & Anor v Primus International… Read more

On 11 March 2019, the High Court delivered judgment in the case of Triumph Controls – v – UK Ltd & Anor v Primus International Holding Company & Ors [2019] EWHC 565 (TCC).

The claim arose out of the acquisition by Triumph, at a cost of US$ 76,530,145, of Primus’ aerostructure manufacturing business including facilities at Farnborough in England and at Rayong in Thailand.

Triumph claimed damages of US$ 63,530,145 in respect of a number of alleged breaches of warranty in the share purchase agreement (“the SPA”), including a failure by Primus to prepare financial projections with care.

As so often with breach of warranty cases, there were a number of issues relating to the adequacy of the notice given by Triumph, but this note will focus on the claim that Primus breached the warranty that “So far as the Sellers are aware, the forward-looking projections relating to the Companies have been honestly and carefully prepared.”

Triumph claimed that Primus was in breach of that warranty on the basis that its projections failed to make adequate allowance for the time and costs involved in transferring production from Farnborough to Thailand and the delay in achieving production from new business. Such failures produced a financial model that overstated future revenues, income and profits.

Triumph argued that carefully prepared forward looking projections would have reflected certain matters in respect of the proposed transfer of production from Farnborough to Thailand by showing a significantly reduced rate of transfer of work to Thailand, lower composites production at Thailand, increased costs of sales and consequently significantly reduced forecasted revenues, income and profits.

While warrantors (such as the sellers on a M&A transaction, or the investee company or founders on an equity fundraising) should generally resist giving warranties that are forward looking, or warranting the accuracy of projections, it is more common for them to agree, in principle, to warrant the basis on which certain projections have been prepared (such as the business plan prepared by an investee company in connection with an equity fundraising).

This note considers the matters of principle which can be distilled from the judgment as a guide to the approach the court will take to similar allegations in other cases.

The key issues were:

1. What were the relevant documents forming the forward-looking projections?
2. What was the scope of the warranty?
3. Were the forward-looking projections carefully prepared?
4. If not, what should carefully prepared forward looking projections have shown?
5. If carefully prepared forward looking projections had shown different key metrics, would Triumph have walked away from the acquisition of Primus or would the purchase price have been lower?

The Judge found as follows regards those issues:

1. The forward-looking projections were not a defined term in the SPA. Ideally, they should have been. However, the parties agreed on the documents which comprised the forward-looking projections for the purpose of the warranty.
2. The key issues of principles are to be found in the judge’s findings that “Primus did not warrant accuracy, only careful preparation. The test is an objective one. Careful preparation required that the [forward looking projections] should be credible and reliable, by reference to evidence-based assumptions or subject to expressly identified risks and aspirations.”

“In the absence of any accounting definition, the Experts agree that the assessment of whether a forecast was “not carefully prepared” is a matter of judgement based on professional experience.

The Experts agree that a forecaster would consider the following steps to produce a “carefully prepared” forecast:

• Consider the latest available financial and operational information up to the date of finalisation of the forecast.
• Consult with relevant members of management with appropriate operational and specialist knowledge.
• Reflect the forecasting practice in that particular business and industry.
• Document the basis of assumptions.
• All assumptions should be subject to a process of review and challenge carried out by somebody independent of the preparer of the forecast.”

3. The Judge found that Primus was in breach of the relevant warranty in that it failed in a number of respects to prepare the forward looking projections with care. In particular, it failed to take into account, properly or accurately, key operational and financial assumptions. As a result, the forward-looking projections failed to adequately model the known operational and financial position of Primus as at the date of finalisation of the forecast.

Clearly any assumptions underpinning financial forecasts have to be sound, by reference to supporting evidence, and accompanied by clear stated assumptions and explanations.

The difficulty faced by Primus in defending its financial forecasts was that it was unable to produce any rational explanation or justification for the sudden increase in the EBIT and EBITDA figures in June 2012. Its strategy to return to profitability was based on the planned transfer of production hours to Thailand. In June 2012, Primus was forced to make downwards adjustments to the planned transfer of production hours for 2012 and 2013. But the effect shown in the financial forecast was an increase in EBIT and EBITDA, rather than a decrease.  A failure to make consequential changes to its plans for future transfers, despite its knowledge of the significant delays and ongoing operational problems in 2012, was careless.

Similarly, in January 2013, Primus’ engineers were encouraged to find additional production hours for transfer, to maintain the financial forecasts and preserve the EBIT/EBITDA predictions. Changes were made, based on aspirational adjustments to production levels, but without any explanations as to how the accelerated production could be achieved or any plan for implementing them. Those unsubstantiated changes were careless.

4. Carefully prepared forward looking projections would have been adjusted to take account of the matters which should have been properly taken account of, if the forecasts had been prepared with care.
5. The Judge decided that, if carefully prepared forward looking projections had shown different key metrics, Triumph would not have walked away from the acquisition of Primus, but the purchase price would have been reduced to reflect the reduced value of Primus based on necessary adjustments to the forward-looking projections.

These considerations are instructive for warrantors to consider when deciding whether or not to give a warranty that a certain projection is carefully prepared (or diligently prepared, or other similar formulations).

If a warrantor believes that a particular forecast they are being asked to warrant has been carefully prepared does not meet that standard based on the above factors, they can either revisit the preparation of the projection (to bring it more in line with the above factors) prior to giving the relevant warranty, or disclose the assumptions on which it is based or any deficiencies in the preparation of the forecast against the relevant warranty.

Finally, it is worth noting, on a practical level, that claims for breach of warranty were capped at a value of US$ 15 million.

Triumph brought another claim, which it argued was not a breach of warranty claim. The value of that claim was capped at US$ 63.5 million.

However, Triumph did not give adequate notice of that claim and therefore was precluded from pursuing it.

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