In blog posts #4 and #5 of the M&A blog series, we discussed the drafting of warranties and indemnities in the sale and purchase agreement. In this blog post, we will explore the differences between warranties and indemnities.

The sale and purchase agreement typically includes both warranties and indemnities, as they are fundamentally a method that is used for allocating risks between the seller and buyer. By providing warranties, the seller accepts the obligation to compensate the buyer if, for any reason, a warranty turns out to be untrue. By providing indemnities, the seller accepts the obligation to indemnify and hold the buyer harmless if, for any reason, the indemnity is triggered. 

While there are similarities between warranties and indemnities, there are also key differences. 

A primary difference is that an indemnity pertains to a specific, previously identified risk that is foreseeable at the time of entering into the sale and purchase agreement and is expected to have a negative financial impact on the target company. For example, an indemnity might read:

A warranty, on the other hand, does not cover a previously identified risk but rather general matters within the target company that are assumed to be true at the time of entering into the agreement. For example, a warranty might state: ‘The target company is not involved in any disputes with a supplier.’ 

A second difference is that a warranty can be limited if the buyer has prior knowledge of a breach of warranty by the seller. The buyer cannot file a claim for breaches of warranty they are aware of (e.g. through conducting due diligence or if the seller has shared this information with the buyer). In the case of an indemnity, the buyer’s knowledge does not affect their ability to lodge a claim, as the indemnity is based on the buyer’s awareness of the issue – it is, after all, a previously identified risk.

A third difference is that warranties are subject to certain limitations of liability. Warranties are often limited to a set period of time (typically, the buyer’s claim period ranges from 12 to 36 months) and money (typically, the financial cap for warranty claims by the buyer is set at 25-50% of the purchase price), but such limitations generally do not apply, or apply to a lesser extent, to indemnities.

A fourth and final difference is that in the event of a breach of warranty, the buyer must prove that a breach of warranty has occurred and that they have suffered damages as a result. In the case of an indemnity, if the previously identified risk materializes, the buyer can effectively pass the issue associated with the risk on to the seller.

In the next blog post (blog post #7) of the M&A blog series, we will discuss asset/liability transactions.