16 December 2016 09:00
Are you buying or selling a business? Do you know the difference between a warranty and an indemnity?
Partner and Head of Corporate and Commercial at Coodes Solicitors, Sonya Bassett, explains the differences between a warranty and an indemnity if you are buying or selling a business.
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:
1. 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.
2. 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, a great deal of negotiation is
around the provision of warranties and indemnities and 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.