When arriving at the contract negotiation stage of selling your business or shares in your company, you are likely to be presented with a lengthy list of warranties by the buyer or its lawyers for inclusion in the sale and purchase agreement (SPA).  While seller warranties, like other terms of an SPA, are negotiable, it is usual for a comprehensive set of seller warranties to be included.

Warranties are a set of statements about your business or company on which the buyer relies in deciding to buy your business, or the shares in your company.  Those statements may be positive (eg, in carrying on the business, you or your company complied with all laws) or negative (such as, there are no claims by third parties against your business or company).  If a seller warranty turns out to be untrue (ie, you breach the warranty), you will be liable for any resulting loss suffered by the buyer.

Warranties will be given by the seller of the business or shares, but if the seller is a company, the buyer may require individuals associated with the seller (eg, its directors) to provide the warranties together with the seller, so that the buyer can bring claims for warranty breaches against any or all of the seller and those individuals.  

While seller warranties are a normal feature of a business or share sale, there are ways in which a seller can manage (and, in some cases, reduce) associated risks and liabilities.

Tip 1 – Disclosure is the key

It is usual (and reasonable) for seller warranties in the SPA to be qualified or limited by reference to all information disclosed (or ‘fully and fairly’ disclosed) by the seller to the buyer before the SPA is entered into.  The effect of that qualification or limitation is that the buyer will not be able to claim a breach of warranty has occurred if the matter giving rise to the claim was properly disclosed to the buyer by the seller before the SPA was signed.  To maximise your ability to rely on any disclosure qualification/limitation in the SPA:

• gather all relevant information and documents in relation to your business as soon as possible in the sale process and include it in a data room to which the buyer and its advisers are given access.  The information presented in the data room should be true and not misleading, as otherwise you could be exposed to claims by the buyer of breach of warranty (eg, a seller warranty to the effect that all information you provided was true and correct), or misleading and deceptive conduct.  This means that both positive and negative facts about your business or company ought to be disclosed, to give an accurate picture.  The data room should have facilities enabling the buyer and its advisers to request additional information and to ask questions, and for you and your advisers to answer them.  For evidentiary purposes, a record of all information (including questions and answers) included in the data room will need to be generated, and there should be a facility to enable the parties to download a copy of the contents of the data room at completion of the sale.  Electronic or virtual data rooms are ideal for those purposes.  There are various third party virtual data room platforms available for sellers to use.
• for added protection, the seller may also provide a disclosure letter or similar document to the buyer prior to signing the SPA, which sets out specific disclosures against specific seller warranties in the SPA.  The SPA would then need to provide that the contents of the disclosure letter also qualify the seller warranties, in the same way as information in the data room.

Note that if your disclosures reveal an issue of material concern to the buyer (eg, a claim or potential claim which might adversely impact the business or the company after completion of the sale), the buyer may insist on the inclusion of a seller indemnity in the SPA to cover the buyer for any loss it may suffer in relation to that specific issue.  Unlike the warranties, your liability under the specific indemnity will not be limited by disclosure, but you could seek to have other limitations apply, such as those mentioned in the next tip.

Tip 2 – Negotiate the inclusion of other warranty limitations and qualifications in the SPA

In addition to the disclosure qualification, it is normal practice for the seller’s (and other warrantors’) liability in respect of warranties to be limited and qualified in other ways under the SPA.  Typically:

• there is monetary cap on the seller’s and other warrantor’s liability.  The cap is usually a percentage of the sale price, up to 100%.  There will be a stronger argument for a lower percentage, the higher the sale price.  Also, there may be different caps for different types of liability (eg, breaches of title and capacity warranties, and some specific indemnities, may attract a higher cap);
• a minimum claim amount (and a minimum amount for a ‘basket’ of claims) is set, so that the buyer is precluded from bringing an individual warranty claim unless it exceeds a minimum claim amount, and until the total amount of all claims exceeds a minimum aggregate claim amount; and
• the buyer will have a time limit, after completion of the sale, within which to bring claims for warranty breaches.  There may be different time limits for different types of warranty claims (eg, tax claims may have a longer tail).  The time limit usually applies to the notification by the buyer of warranty claims, but it is advisable to also include a separate time limit for the buyer to issue legal proceedings for the claim after notification.  Otherwise, as long as the buyer gives you notice of a warranty claim by the claims notification deadline, the claim will be preserved, and the buyer will be free to issue proceedings against you long (even years) after the notification time limit expires.

Tip 3 – Warranty and indemnity insurance

It may be possible to obtain sell-side or buy-side warranty and indemnity insurance cover for breaches of seller warranties.  Whether such insurance is feasible (and obtainable) in a particular case will turn on the size and nature of the transaction and the circumstances of the target business or company.

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For more information, please contact any member of the Sierra Legal team, whose contact details can be found here - LINK.