Ageas (UK) Ltd v Kwik-Fit (GB) Ltd and Another
| Jurisdiction | England & Wales |
| Judge | The Hon. Mr Justice Popplewell |
| Judgment Date | 04 July 2014 |
| Neutral Citation | [2014] EWHC 2178 (QB) |
| Docket Number | Claim No: HQ12X00185 |
| Court | Queen's Bench Division |
| Date | 04 July 2014 |
[2014] EWHC 2178 (QB)
The Hon. Mr Justice Popplewell
Claim No: HQ12X00185
IN THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
Royal Courts of Justice
7 Rolls Building, Fetter Lane
London, EC4A 1NL
Harry Matovu QC and David Scannell (instructed by Shoosmiths LLP) for the Claimant
Patricia Robertson QC and Tamara Oppenheimer (instructed by CMS Cameron McKenna LLP) for the Second Defendant
Hearing dates: 9–13 & 17 June 2014
Introduction
This claim arises out of a share purchase agreement dated 1 July 2010 ("the SPA"), under which the Claimant ("Ageas") acquired from the First Defendant, Kwik-Fit (GB) Limited ("KFGB"), the entire issued share capital in Kwik-Fit Insurance Services Limited ("KFIS") for a consideration of £214.75m. Under the SPA, KFGB warranted the truth, fairness, accuracy and compliance with relevant accounting standards of the KFIS accounts which were relied upon by Ageas for the purpose of valuing KFIS and its subsidiaries, subject to a £5m cap on liability. As is now common ground, KFGB breached those warranties. At the same time as entering into the SPA, Ageas took out a Warranty and Indemnity insurance policy with the Second Defendant ("AIG"), then called Chartis Insurance UK Limited, to protect it against losses resulting from breaches of warranty in excess of the £5m cap under the SPA. The measure of loss recoverable under the policy is that which would be recoverable from KFGB under the SPA, subject to the £5m excess.
The claim against KFGB has been settled. AIG now admits liability under the policy. Ageas claims that the proper quantum of its warranty claim is £17,635,000, giving rise to a claim under the policy of £12.635m; AIG contends that the proper quantum of the warranty claim is £8,792,000 giving rise to a claim under the policy of £3.792m. The quantum issues narrowed considerably in the course of the hearing, enabling me to set out relatively briefly the background necessary to address the issues which remain.
The background
Ageas (formerly named Fortis (UK) Limited) is the holding company for the group's insurance operations in the United Kingdom. At all material times Ageas has predominately been engaged in providing personal lines insurance through a network of intermediary brokers, focusing mainly on the underwriting of motor insurance, but also providing household insurance, travel insurance and a small amount of commercial insurance.
KFGB is a well-known company providing automotive repair, testing and maintenance services, together with associated services. In addition to these services, KFGB developed an insurance broking business under the Kwik-Fit brand, through which it offered motor and household insurance (with various forms of add-on cover, such as breakdown cover and legal expenses insurance). This insurance services division of the Kwik-Fit group comprised KFIS and its subsidiaries, Express Insurance Services Limited ("EIS") and The Green Insurance Company Limited ("TGIC"). Prior to the acquisition by Ageas, KFIS was a wholly owned subsidiary of KFGB and EIS and TGIC were wholly owned subsidiaries of KFIS. I shall refer to the three insurance companies collectively as KFFS, as the parties did at the time and during the hearing.
KFIS was established in 1995 to sell motor insurance products adopting a strategy to take advantage of the customer service calls offered to Kwik-Fit customers following a visit to a branch. Thereafter KFIS's business model evolved to address changes in the insurance market place. There were significant changes in the few years prior to the acquisition, including in particular a rapid rise in the use of comparison websites (or in the jargon of the business "internet aggregators as a distribution channel"). Over the three years prior to the acquisition, the amount of new motor business in the UK sourced through aggregator distribution channels rose from about 30% to about 65%. This was Kwik-Fit's reason for selling the business. In the five years prior to the acquisition the proportion of new business which came from exploiting the automotive customer base dropped from about 80% to about 10%. At the time of the acquisition, the market, and KFFS's position in it, was one of recent and rapid change, which made valuing the business based on projections of future performance all the more difficult.
An important aspect of the KFFS business model was its reliance on an invoice discounting agreement with Barclays Bank to provide it with cash flow. KFIS and TGIC sold insurance policies to customers on behalf of a number of different underwriters. Premiums could either be paid in full at the start of their policy or by monthly direct debit instalments. KFFS was usually required to pay the full premium to the underwriter within 30 days of the commencement of the policy. To cover the funding shortfall on instalment policies, KFFS entered into Debt Purchase Facility Agreements ("DPFAs") with Barclays Bank plc. The precise terms and operation of the DPFAs are no longer in issue in these proceedings; in summary they were invoice discounting arrangements secured on the stream of future income which enabled KFFS to obtain cash from the Bank in respect of policies which were to be paid for by direct debit instalments. As with all invoice discounting schemes this had cash flow advantages for KFFS. It also gave KFFS the ability to offer financing terms to its customers and to generate additional income from this activity. This finance income was a significant element in KFFS's revenue, increasing from about 24% of the total revenue of the business in 2007 to about 44% in 2010.
Ageas was alerted to the proposed sale of KFFS when it received an Information Memorandum from the seller's investment banking advisors, Credit Suisse, on or around 12 March 2010. Ageas regarded it as a potentially attractive investment opportunity, and put together a team of senior personnel from its own staff. Within this team there was considerable past experience of acquisitions and a wealth of knowledge of the operation of the UK insurance market, including both underwriting and intermediary activities. Ageas also retained Deutsche Bank and Deloittes to advise them in relation to the purchase, completing an impressive M&A team.
After conducting due diligence and a valuation exercise (see below), on 6 June 2010 the Ageas M&A team submitted a paper on the proposed acquisition of KFFS to the Management Committee for approval. On 14 June 2010, the Ageas M&A team submitted an updated paper to the Holdings Board. On 15 June 2010, the Holdings Board approved an offer for KFFS in the range of £210m to £220m. On or around 22 June 2010, Ageas made its "final" offer of £215m, which was revised down to £214.75m in order to take into account an additional liability incurred by KFIS. This was accepted and on 1 July 2010 the parties entered into the SPA, whereby KFGB agreed to sell to Ageas the entire issued share capital in KFIS for £214.75m. Completion took place on 2 August 2010 and the purchase price was paid in full by Ageas to KFGB.
For the purposes of assessing an appropriate acquisition price, the Ageas team adopted and relied on a discounted cash flow ("DCF") analysis, as is common in valuing companies. As is well known, DCF modelling involves using projections of the future free cash flow of a company (the amount of cash not required for operations or reinvestment) discounted to arrive at a present day value of a future income stream. The DCF model created by Deutsche Bank and used by Ageas was relatively sophisticated, and involved starting with the projections put forward by KFFS, identifying their key performance indicators and the assumptions which drove them, adjusting those KPIs and assumptions for Ageas' own views of the future for the business and the market, and applying the revised assumptions to the model taking the historical figures from the warranted accounts. Cross checks were also made by reference to other common methods of company valuation, in particular by considering price/earnings ratios and other market transactions. The final version of the DCF model used the figures in the 2010 management accounts and produced an ultimate valuation of £214.5m.
By clause 7.1 and Schedule 3 of the SPA, KFGB gave warranties that the audited annual accounts of KFIS and its subsidiaries for the calendar years 2007 to 2009 were prepared in accordance with GAAP, and gave a true and fair view of the assets, liabilities and financial position of the relevant companies; and that the management accounts for the first five months of 2010 had been prepared on a consistent basis with the annual accounts and did not materially misstate assets or liability or items of income and expenditure or profits or losses for that period.
These warranties were breached by the treatment in the accounts of two aspects of bad debt. One was "the Bad Debt Percentage", a figure used monthly for the purposes of the DPFAs, the result of which was that the revenue and assets were understated in the accounts. The other was "Time on Cover Bad Debt" ("TOCBD"), the result of which was that the revenue and assets were overstated. Overall, the TOCBD errors were greater than the Bad Debt Percentage errors, with the result that the net effect of the errors was an overstatement of revenue and assets. The net overstatement of revenue for 2009 was £1,404,639 and that for the 5 months January to May 2010 was £905,157.
It is not necessary to explain the Bad Debt Percentage error in order to resolve the remaining issues. At the heart of the dispute is TOCBD. This is bad debt which arises out of customers remaining on cover for a period for which they...
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