Warranties are a useful tool for the buyer. They offer the buyer meaningful protection on the business or company it is acquiring and is a means by which the buyer can find out further information beyond the due diligence process. It is for this reason that the warranties and limitations attaching to them, are often the most heavily negotiated provisions in the SPA.
Key learning objectives:
- Define warranties, disclosures, and disclosure letter
- Explain the purpose of warranties
- Describe how sellers can limit their liability with regard to warranties
What are warranties?
Warranties are contractual statements given by the seller of a company or business, as to the condition of that company or business. They are typically included in a schedule in the Sale and Purchase Agreement (SPA).
Each warranty forms a contractual promise about a certain piece of information. The seller may, for example, tell the buyer in the form of a warranty that "there is no litigation which the company is involved in". By giving this warranty, the seller is promising that there is no litigation.
What happens if a warranty proves to be false?
If a warranty proves to be untrue, then a claim for damages will arise.
In certain circumstances there may also be a right to rescind the SPA. For example, where there is a split signing and completion (meaning that completion of the sale of the business or company is conditional on an event occurring), the SPA may provide that it will be terminated or rescinded if there is a breach of warranty arising between the date on which the SPA is signed and completion.
Which areas are typically featured under warranties?Warranties are typically heavily negotiated and should be tailored to the business or company being sold. Despite this, there are certain areas which a buyer will typically want the warranties to cover. These include:
- Financial statements of the company
- Regulatory matters
- Commercial contracts
- Environmental issues
- The seller's authority to enter into the SPA
- In the context of the sale of shares in a company, a warranty that the seller owns the shares it is selling
What is the purpose of warranties?Warranties serve two main purposes:
- Warranties protect the buyer contractually in the event it takes on any liabilities in acquiring the target company or business
- This protection is necessary because in an M&A transaction the law provides no protection for the buyer as to the nature or extent of the assets and liabilities it is acquiring
- Warranties effectively provide for a post-signing price adjustment in the event a warranty given by the seller is later proven to be incorrect and the value of the company or business acquired is thereby reduced
- A buyer will seek to find out more information about the target company or business via the warranties given by the seller
- In addition to carrying out due diligence on the target company or business, the buyer will look to the warranties to discover more information, via the 'disclosure process'
What are disclosures in a Disclosure Letter?
There will be circumstances which do not comply with the warranties. In other words, there will inevitably be certain exceptions or qualifications to the warranties. These exceptions or qualifications are referred to as 'disclosures' and are included in a document referred to as a disclosure letter.
The disclosure letter lists all of the qualifications to the warranties and (although it is technically delivered by the seller to the buyer), is in a form agreed between the seller and buyer.
How do sellers limit their liability under the warranties?A seller will seek to limit its liability for a breach of warranty in a number of ways:
- By including a time limit in the SPA on the period within which a buyer is able to bring a claim for breach of warranty
- If the SPA is silent on this point, then a buyer will typically have 6 or 12 years to bring a claim for a breach of warranty against the seller
- By including financial limits, thresholds and caps on a warranty claim
- By qualifying warranties so that they are subject to 'the seller's awareness'
- If the warranty is qualified by the seller's awareness, then the seller will not be in breach of warranty if it did not know about a particular warranty - e.g. a litigation