Warranties: Don’t make a promise you can’t keep!

Your Share Purchase Agreement will contain a (likely) long list of statements which aim to give certain assurances to the buyer that your business is in good health. These statements are known as the “warranties”. Warranties provide the buyer with some form of protection in the event that any of those statements prove to be untrue and cause the business to suffer a loss post-sale. Under those circumstances, the buyer may be entitled to bring a breach of warranty claim and may seek damages to put the business back in the position it would have been in had that statement been true.

For example, if a seller warrants in the Share Purchase Agreement that the company is not involved in any litigation or disputes and it comes to light post-sale that the company has been involved in a litigious dispute and is now liable to pay substantial damages and court costs, the buyer will look to the seller to recover that amount. The buyer will seek to recover on the basis that the dispute was not disclosed during the sale process and its existence has caused the value of the company to be lower than originally anticipated.

The buyer will want various warranties covering a range of potential eventualities which could result in a liability for the seller post-sale. The warranties can be tailored based on the type of business the target is operating and anything which is uncovered during the due diligence process. Types of warranties will likely cover the following assurances:

• The seller can freely sell their shares.
• The company accounts have been adequately prepared.
• The target has always conducted its business in accordance with any licenses, consents, permits and authorities necessary to carry on the business.
• The target is not subject to any litigation proceedings or involved in any disputes.
• All third-party contracts are binding.
• Any assets to be sold are owned by the target.
• The company has always acted in a tax compliant manner.
• Any intellectual property or trademarks are owned by the target and will transfer freely to the buyer at the time of sale.

Collaboration with advisers is absolutely imperative to ensure you are not giving away too much protection. Your legal and corporate finance team will have vast experience in this area and should/will robustly negotiate on your behalf to ensure that only what is appropriate or expedient is given.

It is usual that those who stand to benefit from the sale will give the assurances and this will usually be the shareholders of the target company as sellers of their shares.

How long am I ‘on the hook’ for?It is essential that the SPA limits the time period during which a claim for breach of warranty can be brought against the seller. Once that time period ends, a claim cannot be brought. The buyer will want this to be as long as possible and, of course, the seller will want this period to be as short as possible. It is usual for warranties to be live for two years from the date of sale, with the exception of any warranties relating to tax which can be live for up to seven years (this seems like a long time but reflects the ability for HMRC to recover any tax liability following any investigations).

How can I limit any potential liability?This is where the disclosure process begins. If any of the warranties are thought to be untrue, now is the time to disclose it to the buyer. The disclosure process will flush out any problems to limit your liability as a seller. This is where your due diligence will give you a good head start as you will have already identified any potential ‘problem areas’ within your business. Claims for breach of warranty are rare if you are well advised and both your due diligence and disclosure processes have been conducted thoroughly.

There are other ways you can limit your liability under the warranties, and it will be up to your legal advisor to negotiate effectively with the buyer’s legal team. Your solicitor should seek to:

• Narrow any broad warranties.
• Identify and exclude any unreasonable warranties to ensure you, as the seller, are clear on exactly what is being warranted.
• Limit the amount you can be liable for in the event of any breach.
• Limit the time period of which you can be liable.

Coming up next: Glenville Walker on all things tax warranties.

Need more help?

If you would like any help and advice on your proposed sale or defining your warranties please contact our specialist corporate team on 0151 305 9650 or email hazel.walker@glenvillewalker.com

This article is not intended to be interpreted as advice.