In the previous blog post (blog post #3), we discussed the legal documents involved in a business acquisition, including the sale and purchase agreement (SPA). The terms agreed between the buyer and seller are documented in this agreement. The sale and purchase agreement is typically a comprehensive contract drafted by the legal advisors of the respective parties. 

A standard component of the agreement is the warranty package provided by the seller. A warranty is not a strictly defined legal term, but what exactly is it then? A warranty can be described as a statement or assurance provided by the seller regarding the target company. For example, a warranty might state: ‘As of the closing date, the target company possesses all necessary permits to operate its business.’ The terms of a warranty can be determined by the parties themselves and must be interpreted on a case-by-case basis. Typically, the sale and purchase agreement includes a long list of warranties covering a wide range of topics, such as financial statements, contracts, employees, permits, and data protection.

The buyer is entitled to rely on the accuracy of the seller’s warranties. If a warranty turns out to be untrue (a "breach") and the buyer suffers damages (such as lost income because the target company is temporarily unable to conduct its business due to the lack of the necessary permits), the buyer may recover the damages from the seller. However, the burden of proof rests on the buyer to prove that the warranty was indeed untrue and that the breach caused actual financial loss.

The sale and purchase agreement includes detailed provisions regarding warranties, breaches, and limitation of the seller’s liability. These may include:

§  a provision requiring the buyer to notify the seller in writing of any breach it discovers within a specified period; 

§  a provision stating that the seller can only be held liable for a breach within a certain timeframe (for example, the seller can only be held liable for up to 24 months after the sale); and

§  a limitation provision capping the seller’s liability at a defined amount (for example, the buyer can only hold the seller liable for up to 30% of the purchase price).

To that end, we will outline the key considerations that the seller and buyer should keep in mind in this regard.

Key considerations for the seller:

§  Ensure that the warranties are clearly and specifically worded to leave no room for ambiguity regarding what the seller is guaranteeing and to minimize any potential differences in interpretation of the warranties. If the buyer can interpret the warranties in multiple ways, it may give the buyer a broader scope for claims.

§  Avoid providing firm warranties about the future, such as the future performance of the target company, as various circumstances could render such warranties untrue. 

§  Inform the buyer as thoroughly as possible about the risks and weaknesses of the target company. Under the sale and purchase agreement, the buyer typically cannot claim compensation for damages resulting from a breach if they were already aware of the situation. In such cases, it is up to the buyer to negotiate a discount on the purchase price or an indemnity, for example (see blog post #5 of the blog series). 

Key considerations for the buyer:

§  Draft the warranties as broadly and openly as possible, as this may provide you with a greater scope for claims in the event of a breach.

§  Tailor the warranties to the relevant business of the target company. For example, when acquiring a software company, warranties related to software and intellectual property rights are likely more relevant than warranties on soil contamination. 

§  Include a comprehensive disclosure warranty in which the seller guarantees that they have disclosed all the information that may be relevant to you as the buyer.

In the next blog post (blog post #5), we will discuss the key considerations to keep in mind when drafting indemnities in the sale and purchase agreement.