This article focuses primarily on the importance and effect of warranties in the sale of business and assets, or of shares, in a company.
The buyer will usually ask the seller to give warranties about the current state of affairs of the business or the company (often referred to as the ‘target’).
These warranties will be drafted by the buyer’s solicitor in the purchase agreement and can involve extensive negotiation between the parties since the buyer will want to minimise any risks associated with the target, whilst the seller will try to limit their liabilities.
What are warranties on sale of business?
Warranties are statements of fact which the seller gives to the buyer in respect of various aspects of the business.
If the buyer can show a financial loss as a result of a breach of warranty, they may be entitled to bring a claim against the seller for that loss.
Why are warranties necessary?
A sensible buyer will carry out due diligence on the target, (as was covered in a previous article here) to obtain as much information as possible so that they can identify any areas of concern.
However, due diligence often gets neglected or is not undertaken thoroughly due to time or cost constraints. Therefore, it is common for buyers to ask for warranties to be included within the sale contract which they can rely on.
Including warranties in the contract will often encourage the seller to disclose any matters which the buyer ought to be made aware of, before the transaction completes.
What should warranties cover in business sales?
Warranties should be tailored to the type of the business or the company being purchased, but will also typically cover areas such as:
- The financial position of the target and the accounts,
- Any past or ongoing litigation or disputes,
- The contracts, employees and the business’ IT systems and intellectual property.
Why are warranties important? Advice for sellers
A seller must think carefully about the warranties they are being asked to give.
It could be that the seller gives a warranty to the buyer, but the warranty is not true or accurate, or could be considered misleading. In such a situation, the seller should disclose any facts which contradict this warranty.
For example, the seller gives a warranty that the personal details of its clients are stored in accordance with UK data protection laws.
The sale then completes, but the buyer discovers that the company is not actually compliant. The buyer could then bring a breach of warranty claim against the seller since the warranty was not true.
Disclosures
Sellers can limit the risk of a breach of warranty claim by making a disclosure. Disclosures are usually drafted in what is known as a disclosure letter. This letter would be considered as part of the main purchase agreement.
Why are warranties important? Advice for buyers
Whilst a buyer may feel that they are adequately protected by the warranties, this may not always be the case.
If there is a breach of warranty, the buyer cannot cancel the agreement (unless permitted under the agreement) but can bring a claim for damages. Either way, a breach of warranty can only be successful depending on certain factors:
- An actual loss has been incurred in the value of the target;
- The loss was reasonably foreseeable by the seller; and
- The loss has occurred as a result of the breach of warranty.
Furthermore, there is almost always a duty on the buyer to mitigate any losses.
Therefore, a buyer might also want to include indemnities in the purchase contract on top of the warranties, as additional protection.
What is an indemnity?
An indemnity in a purchase contract is an agreement by the seller to reimburse the buyer for costs arising from a specified event.
Does the buyer have to prove a breach?
The buyer does not have to prove any actual breach, only that the event covered by the indemnity has happened.
For example, if an indemnity relates to non-compliance with data protection laws, the buyer need not have suffered an actual loss due to breach of those laws, but can nevertheless claim against the seller for any costs incurred by the buyer in making the target compliant.
For this reason, indemnities will usually have to be heavily negotiated with the seller who may want to resist their inclusion in the purchase contract.
How might a seller look to reduce their liability?
As we have mentioned throughout this article, warranties are meant to protect the buyer.
However, the seller will not want to be bound by these warranties forever after the transaction has completed.
The seller might therefore also seek to limit their liability in other ways as follows:
- Time limits – a specified timeframe can be included within which the buyer must bring a claim for a breach of warranty. If there is no specified term, the time limit for bringing a claim will be six years.
- Financial threshold – a cap on damages could set out how much a claim must be worth before a breach of warranty is viable.
- Circumstantial limitations – if, for example, the buyer knew of anything regarding the business prior to finalising the transaction which resulted in a breach of warranty, it could be agreed that this knowledge would make any breach of warranty claim void.
Warranties in business sales: Our advice
Hem Gujadhur, Paralegal in our growing Corporate & Commercial Team, said: “Warranties play an important part in any transaction, and should be carefully considered by both the buyer and seller.
Remember, warranties do not replace the need for comprehensive due diligence.
For more information on how to incorporate or deal with warranties, or if you have any questions, please feel free to contact our Corporate & Commercial Team below.”
Specialist Corporate & Commercial lawyers
At Frettens, our bright and experienced Corporate Team, which is one of the largest in the area, would be happy to assist you in this area.
We have experience in both drafting contracts to include warranties for buyers, and drafting disclosure letters for sellers.
You can get in touch with our team for a free initial consultation on 01202 499255 or by filling out the form at the top of this page.
Comments