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What are warranties?

Warranties are legally enforceable promises made by the seller of a business to confirm that the information given by them about the business is true. This in turn means that the seller has an ongoing liability to the buyer after the business purchase is completed. Usually at least half the documents relate to the warranties and limitations on the seller’s future liabilities which means that considerable time can be spent in negotiating these. If you are buying a business you need to make sure the warranties cover all the aspects that will be important to the business in the future; ignore this at your peril!

Why are warranties important?

Warranties can be critically important to you as the buyer because:
  • There is no legal protection for you regarding the assets and liabilities you are taking on.
  • The rule of “buyer beware” applies which means that unless asked the seller has no obligation to provide you with any information.
  • In deciding to buy the business you have made a number of assumptions (whether you realise it or not) e.g. that the business is not about to be sued by a customer, that the accounts were properly prepared and that the seller is the legal owner of the assets of the business. These can critically affect the value of the business.
  • They give you the right to claim damages from the seller if the warranties are untrue.
  • The potential for you to make a claim motivates the seller to tell you about possible problems.
Warranties are important whether you are buying assets or the shares of a company but, on a share purchase, they are especially important. This is because you are taking on all the assets and liabilities of the business (warts and all). If the company’s directors have made bad decisions you might be stuck with them and their consequences.  

Who gives warranties?

Warranties are given by the owner of the assets or shares being sold. This might be a company or individuals but if it is a company you will need to think about the individual directors who are guaranteeing the warranties. This is because the company may be worthless once the business has been sold.

A word of warning; a warranty or guarantee is only any use if the person giving it has financial assets so, before relying on these, do make some enquiries if you have any doubts about that person’s creditworthiness or financial position.

What is covered by warranties?

Warranties should cover everything that is important to the future success of the business you are buying. This will therefore depend on whether you are buying the shares or the assets and also on the type of business. Usually there are detailed due diligence exercises to find out as much as possible about the business, and the replies to the due diligence questions provide the subject matter for the warranties. Below are some examples of areas usually covered. They might seem obvious but unless you get it in writing you can’t rely on it. The seller may therefore be asked to promise, for example:
  • Accounts – that they have been properly prepared and nothing has changed since then (it could be several months since audited accounts were prepared).
  • Contracts – that where the business depends on a major contract this will continue and that the business can deliver what has been promised
  • Employees – that there are no claims likely or pending; whether buying shares or assets you could be liable for compensation if there are claims by former employees.
  • Tax – that the tax payable will be as shown in the accounts. This is critical for a share purchase and the tax warranties are usually backed up by a separate deed of covenant.
  • Legal requirements – that the business has complied with all legal requirements. This is very wide and can range from food safety to planning law.
For more information please see our Due Diligence for Buyers page.
 
A particular concern when buying assets (but not shares) is that the TUPE regulationswill almost always apply. These mean that the buyer takes on all the employees of the business together with all the seller's obligations to those employees and even to past employees. An employee dismissed because of a business sale is (with certain exceptions) deemed to be automatically unfairly dismissed and entitled to claim compensation from both the seller and you as the buyer. This even applies to redundancies and to a previous attempted sale. This means that, if buying assets, detailed enquiries and warranties are needed to protect you.

What happens if there is a breach of warranty by the seller?

If you suffer loss as a result of a warranty that turns out to be untrue or inaccurate, then, unless you reach agreement with the seller, you will have to go to court and claim damages for the loss suffered and you may also be able to recover your legal costs but this is not guaranteed. Further, the contract will also limit the seller’s liabilities for the warranties so that not all loss will be recoverable.

Some warranties are actually indemnities which means that, even where you can’t recover damages, you may be able to recover costs you have incurred, e.g. if you can sort out the problem you may not have suffered any financial loss but you may have incurred costs in the process.
 
For more information please contact David Heys at Lawson-West Commercial on 0116 212 1000.