Warranties and Indemnities in Acquisition Agreements

Warranties and indemnities are a means of allocating risk between sellers and buyers.

What are warranties?

Warranties are statements of fact given by the seller or sellers at the date of entering into the acquisition agreement as to the condition of the target company or business.

Warranties serve two main purposes:

  • To enable the buyer to elicit information from the seller and require the seller to disclose information about known problems to a buyer
  • To provide the buyer with a remedy (ie. a claim for breach of warranty) if the statements made about the target company or business in the warranties prove to be incorrect or untrue and cause the buyer loss

What are indemnities?

Indemnities are promises to reimburse the buyer in respect of a particular liability or loss suffered.

The purpose of an indemnity is to move the risk of a specific matter from the buyer to the seller and provide the buyer with pound for pound compensation in respect of a specific loss.

What are the differences?

Warranties

  • They only give rise to a successful claim if the buyer can show the warranty was breached and the effect of that breach is that the value of the company or business it acquired is reduced. The onus is on the buyer to show breach of contract and a quantifiable loss
  • An award of damages will be to put the buyer in the position it would have been had the warranty been true
  • A claim will be subject to the normal contractual requirements relating to the remoteness and foreseeability of the loss and the buyer’s attempt to mitigate the loss
  • The seller can disclose any known issues against the warranties
  • Warranties will be subject to the limitations and seller protections included in the acquisition agreement

Indemnities

  • They are usually more appropriate to cover specific risks which are of particular concern to the buyer. They generally cover historic tax issues and can cover issues such as litigation, environmental risks and product liability matters
  • They can be used in circumstances where a breach of warranty may not necessarily give rise to a claim in damages
  • In general, the buyer can avoid issues regarding the quantum of loss which may arise in a warranty claim, ie. mitigation and remoteness
  • Usually indemnities are not subject to the limitations and seller protections set out in the acquisition agreement
  • They are not subject to disclosures made by the seller
  • The seller will resist giving indemnities because it is easier for the buyer to recover under the agreement in comparison to the warranties

Due diligence, being the buyer’s investigation into the target company, is pertinent to the issue of warranties and indemnities.  Warranties should not be seen as a substitute for due diligence as they provide the buyer with advance knowledge of a problem and the opportunity to make informed decisions about whether the issue is material to them, whether to negotiate a price reduction, to seek specific contractual protections, or to walk away from the deal.

It is important to seek legal advice on the due diligence process and in particular in relation to any warranties and indemnities in an acquisition agreement, whether you are a seller or a buyer.

If you have any questions on any of the above, please get in touch with a member of the Corporate and Commercial team by emailing corporate@mlplaw.co.uk or calling 0161 926 9969 and we will be able to talk through your specific needs and our various flexible pricing options.