When a Buyer identifies potential risks during due diligence, they often seek additional contractual protections. These protections typically take the form of warranties and indemnities, which are key provisions in a Share Purchase Agreement (SPA) or Asset Purchase Agreement (APA).
What is the difference between warranties and indemnities?
A warranty is a statement of fact about the company, or an asset given by the Seller whereas indemnities are specific promises to reimburse the Buyer pound for pound for a known risk.
Therefore, the inclusion of an indemnity offers a more direct and certain remedy without the Buyer needing to prove causation and loss.
For a Buyer to bring a successful breach of warranty claim they will need to show that the statement made the Seller was untrue, that the Seller did not make an adequate disclosure as such there has been a breach and that the breach directly caused a specific financial loss or reduction in value in the shares or assets. The Buyer will also need to demonstrate mitigation of loss.
Therefore, you can see that buyers prefer indemnities over warranties.
Common areas of warranty protection
As the Buyer solicitor usually produces the draft SPA or APA, following due diligence and consultation with the Buyer, the solicitor will be able to tailor the warranties accordingly. For example, if a company or business has no IP, a single warranty confirming this may suffice as opposed to pages of irrelevant IP warranties.
The following non-exhaustive list is areas likely to be covered in most acquisitions:
- Accounts: the Buyer will want to see the latest audited accounts and will want the Seller to confirm that the audited accounts give a true and fair view.
- Financing and banking: Buyers will also require appropriate warranties concerning the target’s banking facilities, security documents, bank accounts and compliance with existing loan agreements.
- Real property: the approach to property warranties depends on the bargaining power of the parties. Buyers can opt to fully investigate the properties and accept limited warranties from the Seller, or have a limited investigation into the properties and expect the Seller to provide many warranties.
- Commercial Contracts: the issues to be addressed include requiring the Seller to disclose all material contracts, whether contracts are terminable as a result of the change of control or that no notices have been received purporting to terminate any material contracts.
- Insurance: typical warranties require that all assets have, at all material times, been insured in accordance with industry practice and at their usual replacement value. That there are no outstanding insurance claims and that there is no reason any insurance cover might be avoided.
- IP: this depends on the nature of the business or the assets and what risks may arise should the Buyer not acquire the IP it needs.
- Tax: SPAs in particular tend to include extensive tax warranties. On an asset sale, the tax warranties tend to be more limited as the Buyer is not assuming the Seller’s ongoing corporation tax liabilities.
Limiting liability
Sellers generally seek to limit their exposure under warranties and indemnities, often invoking the principle of caveat emptor (“buyer beware”). Common limitations include:
- Financial Thresholds:
- De Minimis: this is a Sellers way to exclude very small claims to avoid disruption.
- Basket: requires the aggregate claims to exceed a minimum threshold before action can be taken.
- Caps: Sellers often cap liability at or below the purchase price. It is unlikely that a Seller will agree for its exposure to exceed this.
- Time Limits: Restrictions on how long claims can be brought after completion.
These thresholds and caps are heavily negotiated between the parties.
Securing for breach of warranty
Warranties and indemnities can be powerful tools for Buyers, but they are only as valuable as the party giving them. If a Buyer is concerned about a Sellers ability to meet claims or make enforcement difficult or impossible, a Buyer may wish to ask for security.
It is likely that any security sought would have been discussed and agreed between the parties at the Heads of Terms stage, and a Seller may be reluctant to agree to provide security at this point in the transaction.
Some typical methods of security (which are like those taken by sellers to secure instalments of deferred consideration):
- A bank guarantee or a guarantee from the seller’s parent company
- Escrow account or retention.
- Set-off
Summary
Warranties and indemnities are critical in share and asset sales. Sellers must understand the scope and implications of the warranties they provide, while Buyers should ensure these protections align with identified risks.
How can we help?
Warranties and indemnities are often where risk allocation is negotiated in detail. We advise on drafting, negotiating and structuring these protections so they align with the due diligence findings and the commercial position of the parties, including limitations on liability and, where appropriate, options for security. Our aim is to ensure the protections are clear, proportionate and enforceable in practice. Speak to our head of corporate and commercial, Victoria Holland, today.
About the author
Zarenna Porter is a solicitor in the Corporate and Commercial department. Her work spans a wide range of corporate and commercial matters, including acquisitions and disposals, share buybacks, company reorganisations and the drafting and negotiation of commercial contracts and agreements. She has supported businesses operating across different sectors, tailoring her advice to suit the distinct needs of both sole traders and larger corporate entities.