A key element in any business sale negotiation and sale agreement is the settling of warranties, representations and indemnities. These can vary from a few sentences to many pages and, if not treated with appropriate respect, can lead to unexpected dramas and financial headaches long after the deal has been done.
A good understanding of and agreeing an appropriate balance are key to negotiating good warranties, representations and indemnities. These contractual tools are used to afford both the buyer and the seller a degree of protection relating to a business and its performance, its liabilities and commitments. In this article I look at the different provisions in more detail. In part 2 I consider when they should be given and how they might be negotiated.
Warranties
Common to all transactions a seller will normally agree a number of warranties. A warranty is a statement of fact made by the seller e.g. “The Company is not subject to any litigation”. The buyer is entitled to believe that the warranty is true, without making further investigation and, that if it is not true that damages will be paid by the seller to the buyer.
The extent of the warranties may be a matter of discussion at heads of terms stage, but note there is no agreed standard of “minimal” or “usual” warranties.
If the warranty proves to be untrue the damages payable will be limited to the extent that the buyer can prove actual loss. There is no right to terminate the agreement and the buyer must mitigate its losses.
Representations
A little more contentious is the use of representations in sale agreements. A representation is a statement of fact or law made by the seller that induces the buyer to enter into a contract. Stating the obvious, it is a misrepresentation if the statement is untrue.
A representation is much like a warranty, but with a few important differences, including that that the buyer may be able to terminate the contract and/or claim damages in tort for any resulting loss to restore it to the position that it would have enjoyed had the misrepresentation never been made.
Many warranties are beefed up to become representations by the simple and innocuous insertion of “the seller warrants and represents…” If left unchallenged, the seller will be deemed to be making a representation about all of the warranties and the stakes are thereby raised.
Indemnities
An indemnity provides the most fulsome of remedies for a buyer and should be limited to specific concerns about unknown or unquantified future liabilities. Indemnities are often used in the context of historic tax liabilities or potential claims for risks, like environmental matters or employment claims.
Generally an indemnity will be a £ for £ guarantee remedy from the seller to the buyer where any other remedy would be insufficient. There is no duty on the buyer to mitigate and no limitation of the liability unless expressly agreed.
Disclosure
Having given warranties and representations the seller will (quite rightly) wish to limit exposure where they know that they cannot commit fully to the warranty or representation. This is taken care of through disclosure and the agreement should qualify the warranties and representations by reference to matters disclosed to the buyer. In other words, matters that have been drawn to the buyer’s attention which are at odds with the representation or warranty.
These disclosures are normally set out in the “Disclosure Letter”, which sets out all the matters that the seller will require the buyer to accept and will prevent the buyer from making a claim against the seller for breach of the warranty. It will normally include general disclosures, such as matters that can be found on public registers or information supplied to the buyer by the seller in correspondence or through a data room. There may also be specific disclosures against certain warranties.
Limitations
The final safeguard for the seller is the critically important limitation clause.
Time based: the seller may limit the period within which a claim may be made by the buyer. This may be 12 to 24 months, but longer for tax matters. In the absence of a limitation clause, statutory limitations will apply running for 6 or possibly 12 years. That’s a long time for the seller to worry about potential claims.
Maximum value: the seller may limit any claim to the total amount received by the seller or limited to a lesser sum. Without a limitation there may be no cap on total liability.
De minimis: the seller can impose a minimum threshold before a claim can be made. This will generally reflect a percentage of the overall value of the deal. This helps to prevent trivial matters being raised.