Buyers of companies or businesses will often seek warranties from the seller. Buyers may also seek indemnities from the seller. These are contractual protections for the buyer. Warranties and indemnities both minimise the risk exposure of the buyer but there are some key differences between the two. These differences are often not appreciated. The drafting of warranties and indemnities will normally be the subject of lengthy negotiation.
Why are warranties used in a typical share or asset purchase agreement? The principle of buyer beware applies to a purchase of a business. A buyer who is properly advised will want to protect their position by using warranties. These are statements about the company or business being sold, which are given by the seller for the benefit of the buyer. Warranties typically cover all matters relating to the company or business being sold, including specifics relating to the company’s accounts, employees, business property, and its intellectual property. The seller warrants that the statements made about the business are true.
Warranties provide the buyer with a remedy (a claim for breach of warranty) if the statements made about the company later prove to be incorrect.
An important function of warranties is that they encourage the seller to disclose known problems to the buyer. A seller will not be liable for any matter if a proper disclosure is made against the warranty. It is in the interest of the seller to disclose relevant information that would otherwise breach the warranty.
To succeed in a claim for damages in a breach of warranty claim, the buyer must show that the warranty was breached and that the effect of the breach is to reduce the value of the company or business acquired. Normally the buyer’s loss will be based on the difference between the market value of the company had the warranty been true, less the market value of the company taking into account the breach.
With a warranty claim, the buyer is under an obligation to mitigate any loss it has incurred.
A buyer’s knowledge of a breach of warranty prior to the signing of the acquisition agreement may prevent him from bringing a breach of warranty claim following completion of the transaction.
Proper disclosure of matters by the seller will qualify any warranty given.
An indemnity is a promise made by the seller to reimburse the buyer in respect of a specific liability, should it arise. Indemnities are often used where a warranty may not allow a buyer to recover damages. This can happen where the buyer had knowledge of the matter before signing the acquisition agreement.
A seller may have to give indemnities covering specific risks which are of particular concern to the buyer in the circumstances of the transaction. For example, there may be ongoing litigation and the buyer may take the view that an adverse outcome should be borne by the seller.
The indemnity essentially shifts the risk of an adverse indemnified event on to the seller. It also allows the buyer to recover on a pound-for-pound basis the loss due to that event.
Unlike a breach of warranty claim, in an indemnity claim the buyer simply requires to prove that it has suffered loss in relation to the indemnified matter. There is no need to show fault or negligence.
In a warranty claim, a buyer must mitigate any loss it has incurred. However, with an indemnity claim, the law is less clear as to whether there is such a duty to mitigate.
Unlike a warranty claim, the state of the buyer’s knowledge prior to the signing of the acquisition agreement is not a barrier to bringing an indemnity claim (often indemnities are demanded precisely because a disclosure against a warranty has flushed out an issue which is problematic for the buyer).
Although proper disclosure of matters by the seller will qualify any warranty, such disclosure does not normally qualify any indemnities.
Although both are buyer protections, warranties and indemnities are very different animals. Sellers in particular need to understand the differences, primarily to resist the temptation to give unnecessary indemnities under pressure at a late stage in a transaction simply to get the deal done.