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What are warranties?

Warranties are legally enforceable promises made by you as the seller of the business to confirm that the information you have given to the buyer about the business is true. This in turn means that you will have 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 your future liabilities which, means that considerable time can be spent in negotiating these. To protect the buyer the warranties should cover all the aspects that will be important to the business in the future. If you are selling a business you need to make sure that you understand the implications of each and every warranty and check that they are true and accurate.  Do not rely on your memory or recollection – physically check everything!   Warranties should go no further than they need to and should be worded clearly and precisely so that there is little or no room for argument. Remember; the buyer might not be as good at running the business as you are and if it all goes wrong they may blame you!

Why are warranties important?

Warranties can be critically important to the buyer because:
  • There is no legal protection for the buyer as to the assets and liabilities they are taking on.
  • The rule of “buyer beware” applies which means that unless you are asked you have no obligation to provide any information.
  • In deciding to buy the business the buyer will have made a number of assumptions (whether they realise it or not) e.g. that the accounts were properly prepared.
  • They give the buyer the right to claim damages from you if the warranties are untrue or inaccurate.
  • They put you in a position where the buyer can claim against you if you don’t tell them about possible problems.
Warranties are used whether you are selling assets or the shares of a company but, on a share sale, they are especially important. This is because the buyer is 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 all the consequences.

Who gives warranties?

Warranties are given by the owner of the assets or shares being sold.  However, if the assets or shares are owned by your company the buyer will probably ask that the individual directors guarantee the warranties.  This is because the company may be worthless once the business has been sold; this means that you could have a personal liability to the buyer - so even more reason to treat the warranties very seriously.

What is covered by warranties?

Warranties should cover everything that is important to the future success of the business you are selling. This will therefore depend on whether you are selling the shares or the assets and also on the type of business.  The buyer will usually carry out detailed due diligence exercises to find out as much as possible about the business.   Your 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 it is in writing the buyer can’t rely on it.  You may therefore be asked to make a number of promises, 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 that this will continue and that the business can deliver what has been promised.
  • 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 on what you may need to provide please see our Due Diligence checklist here.

A particular concern for the buyer when buying assets (but not shares) is that the TUPE regulations will 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 you as seller and the buyer.   This even applies to redundancies and to a previous attempted sale.   This means that, if selling assets, the buyer will want detailed warranties from you.

What happens if the buyer claims you are in breach of warranty?

If the buyer suffers loss as a result of a warranty that turns out to be untrue or inaccurate then they can claim damages from you. They can take court action against you to recover damages for the loss suffered and they may also be able to recover their legal costs but this is not guaranteed.   However, the contract should contain limits on your liabilities for the warranties so that not all loss will be recoverable.

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