Damages Outside Of Contract: Lessons From Daiichi-Ranbaxy
The arbitral award obtained by Daiichi Sankyo Limited (Daiichi) in its dispute with the Singh brothers, the former promoters of Ranbaxy Laboratories Limited (Ranbaxy), provides an interesting basis for calculating damages in M&A disputes.
Damages generally have a contractual basis, where the aim is to provide an approximate monetary equivalent of an unfulfilled promise.
In an M&A context, for example, upon discovering that the seller's warranties are untrue, the buyer may regret having overpaid for the business and seek recovery of the difference between the consideration paid and what the business was hypothetically worth (i.e. if the warranties were true). This is also known as recovery for "diminution in value".
But contractual damages in M&A disputes have two important limitations.
Firstly, losses, on account of diminution in value, are difficult to prove. Target businesses may be valued using either a discounted cashflow or an earnings multiples method, with the business' value, in each case, determined based on certain assumptions of future cashflows or profitability. A breach of a seller warranty on regulatory matters may lead to recurring penalties and cause reputational loss (thus affecting long-term value) or may result in a significant but one-time penalty only (thus reducing profits for the immediate year, but leaving long-term profitability unaffected). Arguably, the loss is more recoverable in the first case.
Secondly, the buyer's recovery will always be subject to the "rule of remoteness", which prevents recovery of consequential losses unless these losses were reasonably foreseeable. So, for example, if the buyer intended to immediately restructure the acquired business but is unable to do so due to the seller's breach, it is arguable that the lost benefits or synergies of such restructuring could be recoverable only if the seller was also aware of the buyer's post-acquisition plans.
The dispute between Daiichi and the Singh brothers pertained to Ranbaxy's regulatory troubles with the US Food and Drug Administration (FDA).
In November 2008, Daiichi went ahead with its acquisition of Ranbaxy, even though, three months ago, the FDA had restricted the import of more than thirty Ranbaxy medicines. By the time Daiichi initiated arbitration against the Singh brothers in November 2012, the FDA's import restriction, together with the reduced market demand caused by the global financial crisis, had curtailed sales in the US and depressed Ranbaxy's market capitalisation.
In the arbitration, the Singh brothers argued that Daiichi was aware of the FDA's concerns and, by agreeing not to receive any business warranties under the share sale agreements, Daiichi had accepted the regulatory risk of the deal.
Daiichi, on the other hand, maintained that the Singh brothers had mischaracterised the FDA's investigation into Ranbaxy as a "fishing expedition" and that Daiichi was deliberately misled about the "source, nature and severity" of Ranbaxy's regulatory problems in the US.
The tribunal agreed with Daiichi and delivered an award of INR 25.6 million as damages, calculated as the difference between (i) the amount paid by Daiichi in 2008 to acquire Ranbaxy, and (ii) the present value, as of 2008, of the consideration that Daiichi received in 2015, following the merger of Ranbaxy into Sun Pharmaceuticals Industries Limited (Sun Pharma). The present value of the Sun Pharma consideration was determined through a discount rate of 4.44%, which represented the rate of return that Daiichi expected on all its investments.
The Singh brothers argued that "loss of opportunity" was a consequential loss and could not be recovered through damages.
But, according to the tribunal, the misrepresentation by the Singh brothers was made fraudulently, and this meant that damages had to be measured under the tort of deceit (and not under contract).
Unlike contractual damages, damages on a tortious basis aim to restore the parties to their pre-contractual position (i.e. if the misrepresentation had not been made), but the rule of remoteness still applies in both cases. However, damages for deceit are much more extensive because they are not restricted by any rule of remoteness.
This allows the injured party to recover all losses resulting from the misrepresentation. In Daiichi's case, this was the lost opportunity of other investments.
It is safe to say that the result would have been very different had Daiichi claimed for contractual damages for a breach of warranty.
