When you are purchasing or selling a business and its assets, a great deal of negotiation is around the provision of warranties and indemnities. Kirsty Davey, Partner and Head of Corporate & Commercial at Coodes Solicitors outlines the differences between warranties and indemnities.
Updated August 2019
Warranties are contractual statements as to the condition of the business. If the contractual promise is breached, it allows the innocent party to claim damages.
Warranties serve two main purposes:
- To provide the buyer with a remedy, (a claim for breach of warranty), if the statements made about the company later prove to be incorrect and the value of the company is thereby reduced.
- To encourage the seller to disclose known problems to the buyer.
The effect of the warranties are to flush out potential problems. A breach of warranty will only give rise to a successful claim in damages if the buyers can show that the warranty was breached and that the effect of the breach is to reduce the value of the company or business acquired.
The onus is therefore on the buyer to show breach and quantifiable loss. For example, a common warranty is that there have been no changes since the preparation of the last set of accounts. Often a buyer will have only seen the latest accounts which may relate to a much earlier period. If the warranty is given then on receipt of the most current accounts, this position may be reviewed and a claim made if there is a substantial change in the business.
An indemnity is a promise to reimburse the buyer in respect of a particular type of liability, should it arise. Indemnities are often used where a warranty may not allow a buyer to recover because they have been made aware of the potential issues arising.
Indemnities often cover much higher risk elements of the business and are usually most appropriate to cover specific risks that are of particular concern to the buyer. A good example would be an indemnity for any liabilities of the business, such as any risk of personal injury or employee claims. A buyer would often want the higher level of protection afforded by an indemnity so that they are comfortable that any ancillary costs such as legal expenses would be covered, not just the cost of the claim itself.
If you are buying or selling a business, you must ensure that you get good legal advice to ensure that the clauses cover all of the circumstances. You should also be aware of potential pitfalls such as agreeing to “warrant and represent” which would bolster a warranty claim to allow for a claim for misrepresentation as well as damages.
For more information or advice on these issues, please contact Kirsty Davey at Coodes Solicitors on 0800 328 3282 or email firstname.lastname@example.org.