Should I Include Warranties or Indemnities in a Business Purchase Agreement?

You may be aware of the term “caveat emptor”, which commonly translates to “buyer beware”. When buying shares or assets in a commercial transaction, English law operates on the premise that the buyer must ask the questions, obtain the answers, and negotiate terms favourable to their position. While the seller of the target company cannot lie, mislead, or refuse to answer questions the buyer puts to them, the buyer rarely has recourse if a deficiency in the business later emerges that was not accounted for in the negotiation process. However, buyers can better protect themselves by securing warranties and indemnities in the purchase agreement. This article will explain the purpose of negotiating warranties and indemnities in purchase agreements.

Warranties vs Indemnities

Warranties and indemnities generally exist to mitigate the buyer’s liability in an acquisition. You can think of warranties as legally enforceable promises. That is to say, a warranty is where the seller promises the buyer that a particular aspect of the business is as the seller says it is.

While an indemnity is also a legally enforceable promise, it is a promise that the seller will reimburse the buyer if something adverse happens. A seller may want to instil confidence in the buyer by inserting an indemnity clause in the purchase agreement. For example, they could indemnify the buyer against any loss resulting from a dispute.

What is the Purpose of Warranties and Indemnities? 

Most investors acquire businesses because they want to benefit from the business’ assets and ultimately extract a profit from the company. However, when acquiring shares in a business, the buyer also inherits all the business’ liabilities and obligations, such as any contractual obligations and debt liabilities. 

Because the default position under the law is that the buyer inherits all the liabilities not expressly excluded, you will want to know the full extent of a business’s liabilities before buying a business. This way, you can either exclude the liabilities or revalue the business accordingly. 

Any potential legal dispute could create new liabilities (like court judgments). Hence, before you purchase a company, you should inspect its records as thoroughly as possible to ensure you know exactly what you’re getting into. This is the purpose of the due diligence process. 

Warranties and Indemnities in Practice

Indemnities tend to be a little more resolute than warranties because they create steadfast obligations: if x happens, you will pay me y amount. Therefore, the buyers will want to indemnify themselves fully as far as possible. But sellers are unlikely to agree to an unreasonable indemnity. Realistically, they might agree to indemnify the sellers up to a certain amount if the business loses. However, the sellers are less likely to agree to an indemnity for any future dispute that arises after the sellers are no longer owners.

Key Takeaways

The warranties and indemnities accompanying the sale of a business will depend on the negotiating positions of both parties. Buyers and sellers use warranties and indemnities to mitigate their risk. Nevertheless, you should ensure that a solicitor reviews any terms in the purchase agreement, including the warranties and indemnities.

If you need further guidance, our experienced corporate lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. So call us today at 0808 196 8584 or visit our membership page.

Frequently Asked Questions