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Warranties

Buying a business - Warranties

Issues if you are buying a business

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.

Why are warranties important?

  • 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 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. 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?

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.

A particular concern 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 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.

Limitation of seller's liability - issues if you are buying a business

It is normal for the seller’s liability under the warranties prepared when you are buying a business to be limited, and this is done in a number of ways:

Number and wording of the warranties

The best way for the seller to limit their liability is to give as few warranties as possible. However, as the buyer you need to make sure that the warranties cover all the aspects of the business that will be important in the future.

In addition the seller will want to cut back on the wording of the warranties whereas you will want the warranties to be as wide as possible, e.g. the seller might be prepared to warrant that “all equipment is in working order” but you may also want to add “and has been properly maintained” so that you have some reassurance that the equipment won’t break down as soon as you buy the business.

Time limits on warranty claims

Unless stated in the contract, as the buyer, you normally have 6 years to start court action against the seller for breach of warranty (12 years if it is a deed). The seller will want to reduce this as much as possible. The important thing is to make sure that the seller remains liable under the warranties for long enough to allow major problems to arise.  

For tax warranties, the seller’s liability is usually for 6 or 7 years because HM Revenue & Customs can reopen the tax affairs of a company up to six years later.

Financial limits on warranty claims

Unless stated in the contract there is no limit to the seller’s financial liability, so it is therefore normal to include financial limits in the contract.  However, if, in reliance upon the warranties, you will be making substantial investments in the business, e.g. new equipment or premises, you should argue that the limit should reflect this. 

Disclosure

The seller will not be liable for a breach of warranty if they have told you about the breach beforehand. Disclosures can be general (e.g. anything held in public records) or specific. Specific disclosures relate to specific warranties, e.g. if a warranty states that all vehicles are roadworthy the seller may disclose that there is no MOT certificate for a particular van.

Awareness

It is common for the warranties to be qualified by saying that they are true "so far as the seller is aware". You should make sure the contract states that the seller is deemed to have made proper enquiries.  
If the seller is a company, then what’s in the seller’s knowledge depends on its officers. The seller may ask that this be limited to those officers or employees whose awareness is relevant (e.g. directors).