Warranties are contractual promises given by the Seller to the Buyer within the Share Purchase Agreement (‘SPA’), which if proven to be untrue gives the Buyer a rise to claim for damages.

Within a SPA, the Buyer will want numerous warranties to be included, such as:

  • Fundamental warranties are usually core, non-negotiable warranties which include (but are not limited to) a Sellers title and ownership to the sale shares, capacity to enter into the transaction and ensuring no conflict of interests entering into the SPA against the company’s constitutional documentation. These fundamental warranties are not usually subject to a liability cap or time limit for bringing such claim, in contrast with general business warranties.
  • General warranties regarding the Company’s legal, financial and operational state, which include (but are not limited to), accuracy of accounts and financial information, compliance with laws and consents, insurance, disputes and investigations, customers and suppliers, contracts of the company, effect of the sale shares, finance and guarantees, insolvency, assets, intellectual property, information technology, data protection, employment, retirement benefits, and property. You may have industry specific warranties where there are known risks for an industry, for example if you are in a regulated sector, such as CQC, then there may be tailored warranties relevant to that regulator.
  • Tax warranties and often a Tax Covenant, which relate to (but are not limited to) the Company’s tax compliance regarding Corporation Tax, VAT, PAYE and national insurance, to ensure there are no undisclosed liabilities. This element of the SPA would be referred to your accountant to provide advice and assistance on.

The Sellers will avoid liability for a general or tax warranty by making disclosures against that warranty or several of them in a separate transactional document called the Disclosure Letter, which ‘qualifies’ the warranty. Of course, this disclosure in the Disclosure Letter must meet the threshold provided under the definition of ‘Disclosed’ within the SPA.

There will usually be a limitation on claims clause within the SPA, which would be limited to the purchase price actually received by the Sellers in terms of claim made by the Buyers. This is further caveated to include a de minimis amount for each individual claim, which must meet this monetary amount before a Seller is liable to be responsible for such amount. The ‘de minimis amount’ is usually a small proportion (approximately 0.1%) of the purchase price. E.g. de minimis amount within the share purchase agreement set at £1,000. This essentially means that any claims made by the Buyer that are less than £1,000, the Sellers would not be liable for the same unless there are a series of claims which total more than the collective ‘basket clause’.

The ‘basket clause’ within the SPA is a higher threshold for a collection of breaches and is usually around1% of the purchase price in terms of the aggregated value of all individual claims made by the Buyer above the ‘de minimis’ threshold.

The Buyer would want these amounts to be as low as possible to ensure that any potential claims made would be caught within the limit. In contrast, the Seller will want these thresholds to be as high as possible, to limit their liability in terms of reimbursing the Buyer.

Bringing a claim under the SPA for general warranties is usually subject to a time limit between 1-3 years from the date of Completion. The time limit for bringing a claim for breach of a tax warranty is usually up to 7 years from the date of Completion.

An indemnity is a contractual promise to compensate the Buyer for losses or damages incurred due to a particular issue. They are used to give protection to the Buyer for a specific area of risk that has been identified during the due diligence process. It is different from a warranty in that the Buyer does not have to prove that they suffered loss in order to make a claim against the Sellers in the event of a breach.

All the Buyer has to prove is that the loss or expenses were incurred as a direct result of a breach of indemnity and you will be required to compensate the Buyer on a £ for £ basis. These would be discussed on a case-by-case basis during the due diligence process.

For example, if it transpires during due diligence that there is an employment claim being pursued against the Company by an employee then it would be normal for a Buyer to ask for an indemnity in respect of that claim because it is known specific risk.

Negotiating warranties and indemnities is an important part of the sales process for both the Buyer and the Seller. The warranties need to be tailored to each deal, and the Seller needs to make appropriate disclosures where warranties are not correct.

If you’re looking to buy or sell a business, our Commercial Law team can guide you through the process. Contact us on 0113 284 5000 or e-mail us at companycommercial@isonharrison.co.uk.