insights
When buying or selling a company or business, it is important to understand warranties, what to expect from them, and when and how to provide one.
The concept of a warranty is one that we will all have come across at some point in our everyday lives, such as when we purchase a car that comes with a ‘12-month warranty period’, enabling us to go back to the garage if we discover an issue within this time. The purpose of a warranty is to afford the buyer some protection, particularly where significant sums are being expended on that asset. It should therefore come as no surprise that the buyer of your company or business will expect you to provide certain warranties as part of the transaction.
A warranty is, in essence, a contractual promise made by one party to another. In the context of a company or business sale, warranties are often provided in the form of a statement made by the seller(s) as to the condition of the company or business. The contract governing the sale, which is usually referred to as the ‘share purchase agreement’ (SPA) or ‘business purchase agreement’ (BPA) will typically include a detailed schedule of warranties to be provided by the seller(s) covering a wide range of matters. These usually include the titles to the shares or business assets, details on employees, litigation and disputes, property, compliance with laws (e.g, environmental, data protection, consumer protection), intellectual property, accounts, and finances. The scope of the warranties to be provided is usually heavily negotiated by the parties’ solicitors.
The purpose of including warranties in the agreement is twofold: firstly, to use a process known as ‘disclosure’ to elicit information from the seller(s) about any known issues, and secondly, to provide the buyer with some protection against any unknown or un-disclosed issues which come to light after the sale. In that scenario, the buyer may be able to bring a claim against the seller(s) for the loss they suffer as a result of a warranty breach.
Risk allocation in this way contrasts with other transactions where the saying ‘caveat emptor’ (‘buyer beware’) rings true, and the majority of the risk rests with the buyer to carry out their own due diligence. Whilst a prudent buyer will of course conduct their own financial, legal, and commercial due diligence on their target, it is the warranty which provides the buyer with a potential remedy if an issue arises.
The seller(s) and their solicitors will usually prepare a ‘disclosure letter’ containing details of any matters which would make a warranty untrue or misleading. This process involves the seller(s) reviewing each of the warranties to identify any inconsistent matters, and to provide details of such matters to the buyer. For example, a warranty may state that there are no ongoing disputes with any customers or suppliers, and the seller may ‘disclose’ against this warranty by including in the disclosure letter details of any matters which could render the warranty untrue (i.e., a dispute with a customer in respect of monies owed to the business or company). Provided that clear and accurate details of the dispute are included in the disclosure letter, the buyer would not make a claim against the seller(s) even if a loss resulted from the issue disclosed. It is therefore extremely important, as a seller, to make sure that your disclosure letter is as thorough and accurate as possible. If a material issue is disclosed by the seller(s), however, a buyer may seek other remedies for any potential losses such as an upfront price reduction or a specific indemnity in respect of the issue.
Warranties are usually limited in time (i.e. there will be an agreed period from completion of the transaction to bring a claim) and financially (i.e., there will be a certain threshold of loss or damages which must be suffered before a buyer could bring a claim, and an agreed upper cap on liability). The detailed terms of these, and other, limitations are usually heavily negotiated between the parties and their solicitors.
Keep yourself protected: warranties are only one of the key elements of a transaction, but from both sides, they are a fundamental one to understand when buying or selling a business. Therefore, it is wise not to enter into the buying or selling of a business without a solid understanding of what is involved, and ideally seeking expert advice to make sure your warranties do not leave you exposed to risk.
If you would like to talk about this topic further, or if you are considering selling your business, contact us and we would be delighted to discuss how we can help.
Written by Helaina Mann, Howes Percival.