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What you should know about warranties when buying a company

If you are considering buying a company – whether or not you’re acquiring share capital or assets – the position that you will find yourself in is one of caveat emptor, which loosely translates as ‘buyer beware’. As a consequence of this, you will want the comfort and assurance of knowing that you’ve secured what you thought you were buying, which is where the issue of warranties come in.

Here, Michael Key, one of our dispute resolution solicitors, explains how and why warranties are used when buying a company. He explains in more detail how and why warranty claims arise, how they can be avoided, and what limitations and protection may be afforded by particular agreements and documents.

Warranty Claims When Buying A Company: An Overview

Download a Word transcript of this video.

What is a warranty?

Put simply, a warranty is a contractual statement made by a vendor in respect of certain assets of the company. It takes the form of a written statement (or a series of statements), and backs up claims the vendor has made about the business in the process of selling it to you. As touched upon above, the purpose of any warranties is to provide you with some security regarding future outlays, in light of the fact that not all potential issues with the business will necessarily materialise during the due diligence process. On that note, it’s important to point out that the purpose of warranties is to complement the due diligence process, not be separate from it.

When are warranties likely to be necessary?

Broadly speaking, there are likely to be several types of warranties necessarily given in relation to multiple areas. Some examples include account issues, employment issues, commercial contracts, environmental matters, legal disputes, machinery and tax matters, to name but a few.

Why do warranty claims arise?

Generally speaking, the main reason why warranty claims arise is because the purchaser hasn’t got what they thought they were buying in the first instance. If this happens to you, you would ultimately look to the warranties given by the vendor when the purchase of the business was being finalised in order to see whether or not you have any right to either unravel the purchase, or any grounds to sue the seller for damages.

How can warranty claims be avoided?

The most crucial point to be aware of when it comes to avoiding warranty claims as a buyer is to ensure that sufficient time and credence is given to the due diligence process, making certain that you or your solicitor has rigorously checked through all the warranty claims made by the vendor, which will include making sure they’ve disclosed against everything possible in the disclosure letter. 

What are Vendor Protection Provisions?

Something that both parties in the sale process need to give due consideration to are any vendor protection provisions in the agreement. The vendor protection provisions, generally speaking, will govern how any claim in respect of a warranty is dealt with. Quite often, there will be specific procedures embedded in the agreement: these procedures will include and encapsulate specific time limits and, more often than not, there will be explicit monetary limits in respect of a particular head of warranty claim, or composite limits in respect of warranty claims in general. It’s quite common to find what are termed de minimis limits; in other words, minimum thresholds for bringing a warranty claim (for example, £5,000 or £10,000 for each head of claim), otherwise it may not be economically viable to make a claim in the first place. 

What other considerations are important?

An important (but often overlooked) factor in considering and avoiding potential warranty claims is the lack of attention paid to the dispute resolution clause in the agreement, at the negotiation stage of the sale of assets or capital. It is common to find that when individuals or companies are making a purchase, they don’t actually envisage that a dispute will arise; however, in the cold light of day it can often be anticipated or pinpointed where or what the disputes are likely to originate from. Consequently, focus should be placed on tailoring the dispute resolution clause to make sure that it best suits your purposes, whether you are acting as a purchaser or the vendor.

Ultimately, paying careful attention to such matters can pay dividends in the long run in circumstances where a dispute arises, so engaging thoroughly with the sale process in this regard can prove invaluable further down the line.

What next?

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