Warranties
Warranties
There are no implied terms and conditions on the sale of shares so that in effect, all risk would lie with the buyer. In the absence of a specific misrepresentation, the buyer takes the company as is. There is no duty on the buyer by law to make any disclosures. For this reason, the seller of shares usually gives lengthy warranties to the buyers.
A warranty is a statement of fact by way of a promise in an agreement on the part of one party. Its breach entitles the other party to damages/compensation for financial loss thereby arising if the statement is untrue or inaccurate. In this context, the measure of loss is the difference between the value of the company as if the warranty was true and correct and its value in the circumstances of the breach.
Effect of Warranties
The warranties seek to ensure that the seller makes disclosures in relation to unanticipated matters which are better known to it or are more likely to be within its knowledge. The purpose of a deed of indemnity is to meet specific unanticipated liabilities.
The effect of breach of a warranty is to readjust the price as between buyer and seller retrospectively. Under contract principles, the amount of damages for breach of warranty is the difference between the value of the shares had the warranty been true and its actual value in the circumstances of the breach.
The buyer may not be able to claim under a warranty claim where he is actually aware that the warranty is untrue. This depends on the particular wording in the circumstances. This does not apply in respect of indemnity claims.
Share Purchase Agreement Warranties I
Generally, a buyer agrees in principle to purchase a company for a particular price and settles the other commercial terms on the basis of the latest audited accounts and on the assumption of normal trading.
Any unanticipated liabilities and obligations would reduce the negotiated value of the shares. Where unanticipated matters arise in the course of due diligence, the buyer may legitimately seek a price reduction or adjustment including the retention of monies and further security to cover the risk where appropriate.
The share purchase agreement will commonly comprise principally of a schedule of detailed warranties. The share purchase agreement itself will contain substantial warranty provisions which give effect to the schedule of warranties. The particular warranties given will depend on the nature of the business concerned.
Share Purchase Agreement Warranties II
Share purchase agreements commonly provide that each warranty is true, complete, and accurate in all respects and is not misleading. It may be declared specifically that the buyer has entered into the share purchase agreement in reliance on the truth and accuracy of the warranties.
If there is a conditional agreement it may be provided that the warrantor’s status shall ensure that there is no breach of warranty during the period between the share purchase agreement and completion.
The sellers / warrantors may be obliged to notify the buyer upon becoming aware of any breach. In some cases, the breach may be a matter which is within their knowledge, but not readily apparent to the buyers or the management of the target company. The failure to notify would be itself a breach.
Breach of Warranty
With a breach of warranty, the buyer is to be put in the same position in so far as money can do so as if the warranty was true and accurate. A warranty claim extends to loss that may fairly and reasonably be considered as arising according to the usual course of things from the breach or is such that is may reasonably be supposed to be in the contemplation of the parties as the probable result of the breach.
Where a party has special knowledge of possible loss and effectively takes the risk in relation to the buyer’s prospective loss, this greater loss is the measure of damage. The nature of the formulation can lead to significant disputes regarding the extent of loss and liability for its consequences.
It is sometimes provided in order in favour of the buyer that in the event of a warranty claim the buyer may choose to be paid damages equal to the reduction in the value of the shares as a result of the breach or the amount of the relevant liability or loss together with costs and expenses. Such a clause would be usually resisted by the seller.
A breach of warranty may not impact on the share value, which is the measure of loss in a warranty claim. Many losses may not impact on the value of the shares in the economic sense but may have an adverse effect on the target company. They may be appropriate as the subject of an indemnity. An indemnity allows for recovery for loss. The indemnity may be made in favour of the company itself.
Nature of Warranty Liability I
Questions may arise as to the basis on which the warranties are given, where there are multiple sellers/ warrantors. Warranties may be given on a several and proportionate basis. More commonly, they are given on a joint and several basis. Commonly, the maximum liability is limited to the price receivable by the warrantors/sellers collectively or individually.
Where the warranties are given on a several and proportionate basis (which requires very clear language), each warrantor is liable only for a proportion of the relevant liability. The more common position of joint and several liability leads to the possibility of full liability on the warranty for each warrantor to the buyer, with a possibility of contribution from other co-warrantors (subject to their solvency and payment to the third party).
Joint liability (which is rarely found by itself) is a single liability for all the parties concerned. Certain technical consequences follow. Several liability is the individual liability of each warrantor for the whole obligation. A buyer will usually require joint and several liability by each warrantor as this is the most favourable basis from its perspective.
Nature of Warranty Liability II
It is commonly provided that each warranty is separate and independent. It is commonly confirmed that the warranties continue notwithstanding completion. This may appear to be a given, but there are principles in other contexts (real property sales), whereby the contractual provisions may merge in the conveyance i.e. the transfer of the shares and cease to apply. This clause seeks to avoid this possibility as the transfer will not usually contain any substantive warranties.
Where the share purchase agreement is conditional, or there is a delay between signing and completion, it is usually provided that the warranties will continue to be true and applicable as on the date of completion and that they are deemed to be repeated.
Given that matters may arise outside the seller’s/warrantor’s control, it may be entitled to issue a further disclosure letter so that they are relieved from liabilities in respect of new matters. Equally, the buyer would wish to have the right to terminate and rescind the agreement if it is dissatisfied with a matter subsequently thereby arising.
Calculating Damages
The agreement may declare the basis on which the buyer will be compensated. This may be on a contractual, tort or indemnity basis. A contractual basis is the usual and narrower basis as recovery is limited to losses which arise naturally in the ordinary course of events. Generally, though not necessarily, it excludes consequential loss.
The tortious measure is that used in the case of civil wrongs. and provides a greater and more liberal test of the remoteness of liability. This is more favourable to the buyer. The indemnity basis is fundamentally different and is usually more favourable again to the buyer. It is an undertaking to make good a particular loss on a Euro for Euro basis without mitigation.
The sellers / warrantors may be required by the buyer to waive any rights they have against the managers of the target company in respect of any misrepresentation or omission emanating from them which causes a breach of the warranties or indemnity. The purpose is to prevent the sellers facing liability back on the company which the buyer has purchased in respect of information supplied by directors, management etc. The principle might otherwise operate as a matter of the management authority or under principles of vicarious liability.
Any payment by the sellers/ warrantors is commonly deemed to be an adjustment of the price. The primary purpose is to reduce the purchase price for tax purposes.
Alternatives to Warranties; Property
In some cases, there may not be property warranties. Instead, there may be a title investigation or certificate of title by the seller’s solicitor or the company’s solicitor in relation to title to the property. This may be appropriate where those parties are familiar with the title and other legal compliance issues. This can avoid duplication. If a certificate of title is given, less extensive property warranties are given.
The buyer’s solicitors may undertake an investigation of title. In this event, there will probably be an investigative procedure in respect of the company’s title to the property.
The alternative is to give detailed property compliance warranties. This may be appropriate where there is a relatively short time or a significant number of properties are involved. A mixed approach could be taken if there are different categories of real property.
Limitation of Warranties
The buyer may seek to have the warranties framed in absolute unconditional terms. The sellers will seek to minimise and reduce the prospective liability by negotiating limitations as well as changes to the substantive clauses themselves, where possible.
It may be provided that the disclosure letter is not to apply to certain warranties and is not to mitigate the obligations thereunder. It will not usually apply to the tax indemnity. It may be inappropriate in other cases, where for example a self-contained certificate of title is given in relation to the title to property etc.
The principal and most significant dilution or limitation of liability on the part of the seller/warrantor is effected by the disclosure letter. This is the subject matter of a separate article. Restrictions may be placed on recovery from sellers by way of substantive and procedural terms. These are a matter for negotiation and discussion.
Maximum and Minimum Claims
Sellers and warrantors will generally seek to limit the maximum amount for which they may be liable under the warranties to the consideration or purchase price received by them. It may be the purchase price plus any liability of the target company assumed and discharged by the buyer under the share purchase agreement.
In order to prevent vexatious and trivial claims, there is usually a minimum financial threshold below which claims may not be made. The sellers may wish to provide that where there is a claim above the amount, the excess only is allowed.
However, this is not generally acceptable so that when the liability the subject of the breach of warranty exceeds the “de minimis” or minimum amount, they are liable for the full loss. The de minimis amounts are commonly somewhere between 1.5 % an 0.5% the purchase price.
Time Limits I
In the absence of any specific provision, the time limits under the Statute of Limitations for bringing a claim will apply. They are relatively long. There is a 6-year time limit in contract claims running from the date of breach of the contract. If the share purchase agreement is executed as a deed, a 12-year time limit applies.
This is generally from the date of completion. Where a tort claim applies (which would be unusual in this context), the time does not run at all until there has been loss and damage. The loss and damage can occur without it being evident or known.
These default positions are usually significantly shortened by the terms of the share purchase agreement so that there is a less prolonged contingent liability on the part of the seller.
The shorter periods which are applicable under the agreement and deed to the warranties and the indemnity will not apply in the case of fraud or knowing concealment. In these cases, the statute of limitations itself does not usually apply at all. The share purchase agreement liability extension may be expressed differently to the concept of fraud that applies under the Statute of
Time Limits II
A limit of two to three years is commonly applied in respect of the breach of warranties. This represents a period which will have one or two audits and financial reporting cycles. It is assumed that most significant problems, if any, are likely to emerge within this period and become evident to the buyers,
In the case of the tax indemnity, there is generally a longer period customarily 4 to 6 years. This represents the period during which Revenue can revise a taxation return or assessment. However, Revenue’s powers of revision are not subject to this limitation in the case of [negligence] or fraud.
Where there are significant risks of liabilities, longer term indemnitees and warranties may apply. In recent years, there has been legislation and court decisions which have effectively increased the extent of potential liability for environmental contamination so that they may extend for several decades. In this case, periods of 10 years or more may be required in the agreements.
Indemnities
Specific legal issues and contingencies which emerge in the course of the due diligence process may be the subject of an indemnity. An indemnity is a specific promise to keep another person whole / reimbursed in full for a loss and liability. It provides much greater protection for the purchaser/beneficiary.
In the case of an indemnity, there is no obligation on the beneficiary to mitigate his loss. There is an entitlement to a full “Euro for Euro” recovery. In contrast, in the case of a warranty, general contractual principles apply. Only loss that arises naturally in the ordinary course of matters from the breach is recoverable. See the articles on contractual damages.
There is usually a separate tax indemnity. Indemnities are usually given in relation to tax liabilities that are not expected and provided for, that arise after completion and relate to the period prior to completion. An exception is usually provided for where the provision is made for the taxation liability in the accounts or where it is excluded because it is otherwise factored into the price.
Security for Warranty Claims I
If the sellers are non-resident, it may be difficult to enforce a claim. They may transfer assets abroad or simply dissipate the proceeds of sale such that there is no effective means of enforcing a warranty or deed claim. The seller’s /warrantor’s liabilities under the share purchase agreement for a warranty claim may be secured.
The security may be given by another group member or the ultimate parent company where the target company was part of a group.
A guarantee may be given by a bank or other financial institution. The liability may be secured by way of a charge over the seller’s assets. Part of the purchase monies may be placed in escrow pending completion of part or all of the warranty period. The period of retention may not be the entirety of the warranty period. It may be for one or two years only.
Where there is a deferred consideration or earnout provisions, this creates intrinsic security for warranty claims. A claim may be satisfied by way of set-off against the obligation of the target company to pay the deferred consideration. The claim may impact directly on the criteria for earnout (in that it affects the profit or some other measure) so that it causes a failure on the part of the seller to achieve the earnout targets of themselves, reducing the deferred consideration and giving an effective form of security as such.
Security for Warranty Claims II
If monies are placed in escrow, they are not released until the relevant conditions are complied with. There may be a mechanism for verifying compliance. Monies may be placed with the buyer or seller’s solicitor as escrow agents. Alternatively, they may be lodged with an independent agent such as a bank. There may be a separate formal escrow agreement defining the terms on which the escrow payment is released.
A deferred payment may be appropriate where there is a particular contingency which may devalue the target company. The claim may be resolved within a relatively fixed period. This may be the case in respect of legal proceedings which could have a very significant impact.
In other cases, the deferred element could be in the nature of a bonus should the company meet certain criteria.
It may be possible to obtain indemnity insurance against warranty claims in share purchase agreements.Generally, if available at all, if is restricted to cases where the warrantor is not involved in the management of the company. It is not generally possible to get insurance against one’s own failures or breaches of duty. The policy may be taken out by the seller and assigned by way of security to the buyer. The policy may exclude certain risks which the insurer is unwilling to cover.
Full Disclosure
The buyer may seek confirmation that the seller has given all information which ought to have been produced in order to allow the buyer to make a proper assessment and does not know of anything which could affect the decision to buy.
This is likely to be resisted by the seller as being too wide. They will argue that it is a matter for the buyer to assess the prospects and that a seller should not be held to such a wide and potentially vague obligation.