In this Q&A, Hem Gujadhur outlines what warranties are in business sales, looks at whether they’re necessary and provides advice for both buyers and sellers.

What are warranties on sale of business?

Warranties are statements of fact which the seller gives to the buyer in respect of various aspects of the business.

If the buyer can show a financial loss as a result of a breach of warranty, they may be entitled to bring a claim against the seller for that loss.

Why are warranties necessary?

A sensible buyer will carry out due diligence on the target, (as was covered in a previous article here) to obtain as much information as possible so that they can identify any areas of concern.

However, due diligence often gets neglected or is not undertaken thoroughly due to time or cost constraints. Therefore, it is common for buyers to ask for warranties to be included within the sale contract which they can rely on.

Including warranties in the contract will often encourage the seller to disclose any matters which the buyer ought to be made aware of, before the transaction completes.

What should warranties cover in business sales?

Warranties should be tailored to the type of the business or the company being purchased, but will also typically cover areas such as:

• The financial position of the target and the accounts,
• Any past or ongoing litigation or disputes,
• The contracts, employees and the business’ IT systems and intellectual property.

Why are warranties important? Advice for sellers

A seller must think carefully about the warranties they are being asked to give.

It could be that the seller gives a warranty to the buyer, but the warranty is not true or accurate, or could be considered misleading. In such a situation, the seller should disclose any facts which contradict this warranty.

Sellers can limit the risk of a breach of warranty claim by making a disclosure. Disclosures are usually drafted in what is known as a disclosure letter. This letter would be considered as part of the main purchase agreement.

Why are warranties important? Advice for buyers

Whilst a buyer may feel that they are adequately protected by the warranties, this may not always be the case.

If there is a breach of warranty, the buyer cannot cancel the agreement (unless permitted under the agreement) but can bring a claim for damages. Either way, a breach of warranty can only be successful depending on certain factors:

• An actual loss has been incurred in the value of the target;
• The loss was reasonably foreseeable by the seller; and
• The loss has occurred as a result of the breach of warranty.

Furthermore, there is almost always a duty on the buyer to mitigate any losses.

Therefore, a buyer might also want to include indemnities in the purchase contract on top of the warranties, as additional protection.

Read the full article, where I look at warranties in much greater detail, here.

Warranties in business sales: Our advice

Warranties play an important part in any transaction and should be carefully considered by both the buyer and seller.

Remember, warranties do not replace the need for comprehensive due diligence.

At Frettens, our bright and experienced Corporate Team, which is one of the largest in the area, would be happy to assist you in this area.

We have experience in both drafting contracts to include warranties for buyers, and drafting disclosure letters for sellers.

You can get in touch with our team for a free initial consultation on 01202 499255.