A warranty is an assurance or a promise that you make as the seller of the business. A breach of warranty will give rise to a claim for damages.
The sale agreement will almost always include pages and pages of warranties which are requested by the buyer.
Warranties relating to you as the seller (e.g. you are not insolvent), or in a share sale, the shares themselves (e.g. the shares have been issued legally), do not typically need detailed consideration.
You will, however, need to carefully consider the warranties relating to the business itself. Such warranties typically include matters such as:
- information provided by the seller in the context of the sale is true, accurate and not misleading;
- assets, including intellectual property, belong to the business;
- contracts with third parties are binding;
- taxes have been paid or provisioned in full; and
- disputes are not expected.
As the seller, you will need to carry out the following actions to ensure that the risk of future claims is appropriate.
1. Read the warranties carefully
We will advise you on what the warranties mean, but you should read every word. Warranties may need to be amended to fit the factual circumstances or be deleted as not being relevant to the business. You will need to make sure that you are comfortable with the scope of the warranties and that you understand what will happen if there is any breach.
2. Qualify the warranties by materiality
It may be unreasonable to expect that a warranty is absolute. For example, the buyer might want an absolute warranty that the business has performed all of its contractual obligations with third parties. That might be unreasonable as many contracts have obligations which are relatively minor. The warranty could be qualified so that it is made only 'in all material respects'.
3. Qualify the warranties by information which is being disclosed
You will provide the buyer with various items of information which are exceptions to the warranties during the negotiation for the sale - this process is called ‘disclosure’. The warranties should be qualified by the disclosure information, so that the buyer is not able to claim as regards information which has been disclosed.
4. Qualify the warranties to the knowledge of the seller
There will be other warranties where it would be unreasonable to expect you, as the seller, to have absolute confidence in the factual circumstances. For example, the buyer might want a warranty that no customer intends to cease doing business with the company. You might consider qualifying this kind of warranty so that it is made only 'to the best of your knowledge'.
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5. Think about when a warranty is being given
Warranties relate to a certain state of affairs at a particular point in time. Usually, the warranty is given as at the date of the sale agreement. Warranties should rarely, if ever, relate to future matters. Although you can reasonably be required to provide accurate information about past and present affairs of the business, you cannot be expected to do so for future events.
6. Include an overall cap on your liability under the warranties
The maximum amount that the seller has to pay if a warranty is breached is usually limited to the purchase price for the business.
7. Include thresholds for making a claim under the warranties
The sale agreement should also include a minimum amount, below which, a claim for breach of warranty cannot be made. The idea is to ensure that a claim for breach of warranty is made only for serious issues. There is also often a second threshold relating to the aggregate value of all claims.
8. Limit the time in which a claim under the warranties can be made
The sale agreement should also prescribe a specific time in which a claim can be made following the sale. The idea is to give the seller a ‘clean break’, after which the buyer can no longer bring a claim. Sometimes there are different periods for different types of warranty, for example, for tax.
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