M+A: Warranties – what are they?

Purpose of warranties

Warranties are used by buyers in conjunction with due diligence investigations as a way of endeavouring to ensure that the buyer obtains the target company/target sale assets, at completion, in the condition which it believes that it negotiated. Warranties are given as a means of supporting or validating the sale price and as a mechanism for verifying the seller’s answers to questions posed by the buyer during the course of due diligence and the contract negotiations in general.

Warranties are in essence statements of fact and they express, in the form of a contractual promise, what the buyer requires. They law imposes upon the seller an obligation to compensate the buyer in damages for the losses suffered if the target company/target sale asses and/or the seller do not respectively meet the requirements contained in the warranties.  

Warranties as representations

Warranties are commonly expressed to be representations. This means that the warranties are not only contractual promises but also the documentation of the representations which induced the buyer to enter into the sale agreement. One of the major stumbling blocks in a misrepresentation action is proving on the balance of probabilities precisely what the seller represented to the buyer. If those representations are reduced to writing then this obstacle is removed. Any representation whether reduced to writing or not can be used against a seller, so care needs to be taken in relation to all communications with the buyer and its advisers.

Warranties given in the context of a sale of shares or sale of business assets agreement are almost always confined to a known period of time which may commence on a date prior to the date of the sale agreement but generally conclude on the completion date of the sale agreement.

Future representations

It is generally accepted that all sellers should be careful not to give warranties/representations regarding future matters including such things as the future financial position or performance of the target’s business.  Sale agreements often contain express statements to this effect to negate any subsequent arguments to the contrary raised by a disappointed buyer.

Absolute warranties

Warranties tend to be drawn in absolute terms (i.e. they are not qualified by expressions such as “to the best of the vendor’s knowledge and belief … ” or words of similar effect). As a consequence the seller is promising that even in circumstances where there are matters of which the seller is unaware or that may be undiscoverable by it and its advisers at the time the warranty is given, it shall be liable for any loss or damage suffered by the buyer (and/or target company if applicable) that occurs post completion.   The reason for this is that warranties effectively allocate legal risk between the contracting parties (i.e. the seller and the buyer). In instances where but for the acquisition of the sale shares/business assets the buyer would not have suffered the loss or damage that subsequently arises, the view is taken that the seller must bear this loss or damage because that would have been the outcome had the sale transaction not occurred.  This is why warranties that relate to such matters as compliance with taxation laws; compliance with the accounting standards and so on are typically expressed in absolute terms. 

Qualified warranties

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