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. 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.
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.
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.
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.
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.
It is normal for your liability under the warranties prepared when you are selling a business to be limited, and this is done in a number of ways:
The best way to limit your liability is to give as few warranties as possible.
In addition you should also cut back on the wording of the warranties themselves whereas the buyer will want the warranties to be as wide as possible, e.g. you might be prepared to warrant that “all equipment is in working order” but you should not agree to add “and has been properly maintained” unless you know what this means and you can show it has been done.
Time limits on warranty claims
Unless stated in the contract the buyer normally has 6 years to start court action against you for breach of warranty (12 years if it is a deed). You should therefore try to reduce this to a few months or at least 2 or 3 years. The important thing for the buyer is to make sure that you remain liable under the warranties for sufficient time to allow major problems to arise but you should not agree to any longer.
For tax warranties, your 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.
Time limits for notifying and making warranty claims
You need to be told promptly when the buyer becomes aware of a possible claim, otherwise, even if the liability period is reduced, the buyer can turn up at the end of that period with a “shopping list” of claims. It is therefore usual for the buyer to have an obligation to notify you of the possible claim within a short time after they find out about the breach, e.g. 1 or 2 months. You should also require that the buyer takes court action within a set period after the end of the liability period. Again this is to provide certainty and so that the buyer can’t keep coming back.
Financial limits on warranty claims
Unless stated in the contract there is no limit to your financial liability so it is therefore important to include financial limits in the contract. An obvious limit is the purchase price so that, whatever the loss to the buyer, this is the total amount for which you could be liable. However, often the price includes the value of machinery and property of which the buyer has the benefit after completion. It is therefore sometimes possible to separate out the limits, partly to machinery and party to goodwill or that the overall limit should be the purchase price minus that amount of it allocated to the machinery or property. In contrast, the buyer may argue that they may suffer other loss if, in reliance upon the warranties, they have made substantial investments in the business, e.g. new equipment or premises.
At the other end of the scale as seller you will want a minimum amount for claims, e.g. £1,000 so as to prevent the buyer making low value claims that are too expensive to defend.
You will not be liable for a breach of warranty if you have told the buyer 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 you may disclose that there is no MOT certificate for a particular van.
It is common for your warranties to be qualified by saying that they are true "so far as the seller is aware". The buyer will want to make sure the contract states that you are deemed to have made proper enquiries.
Other limits on liability that can be included to protect you are:
- Preventing double recovery – this is to prevent the buyer from making a claim if there are other ways of making good the loss e.g. insurers, or a debtor
- Post-completion acts to be disregarded – this is to make sure that you are not liable for things the buyer does after completion
- Limiting liability to the seller's ownership – if you have only owned the assets or shares for a short time you may not be fully aware of the previous history of the business. This is a potentially controversial clause because the buyer will argue that you, as seller, should have your own warranties from the previous owner
- Disregard of changes in the law – in a heavily regulated industry you should argue that you should not be liable for loss where there has been a change in the law.
Download our Guide to Selling your Business here.