As the economy slows, acquisitive businesses are looking closer than ever at the warranties and price adjustment provisions in their recently completed transactional agreements; their aim – to claw back part of the money they’ve paid for the company. This is especially the case where economic circumstances negatively impact the value of the acquired company and the purchaser perceives the deal to be a bad one.
What are warranties?
A warranty is a legally binding promise. In the context of selling a business, warranties are usually promises or assurances given by the seller to the purchaser about the state of the business. Typically, warranties are negotiated between the seller and the purchaser, with the purchaser seeking to obtain as much comfort as possible about the state of the business they are about to acquire.
Warranties are a way of reducing risks associated with purchasing a company. Purchasers will typically want assurances about a range of matters, ranging from the financial state of the company, the state of its assets, employment records and accuracy of accounting information filed at Companies House to details of any disputes the company is or has been involved in.
Conversely, the seller will attempt to limit the scope of the warranties provided by disclosing certain matters to the purchasers prior to completion. These disclosures – often contained in the stand-alone disclosure letter – will effectively caveat the warranties provided. For example, whilst the seller may have warranted that the company’s accounts are accurate, they may disclosure the fact that an innocent mistake was made in a particular year. By disclosing such facts – which would otherwise amount to warranty breaches – the seller reduces the chances of inadvertently breaching the warranties provided and therefore being pursued by the purchaser.
It is also difficult for purchasers to pursue claims if they were made aware of the warranty breach prior to completion – regardless of whether the seller specifically disclosed it.
Is there a breach?
Deciding whether a warranty has been breached is rarely a straightforward question, particularly if the suspected breach relates to the financial affairs of the company. It is therefore often necessary to seek early input from an accounting expert to analyse a potential claim. Equally, if a seller warrants that certain technical equipment owned by the company is in good condition, experts in that field of technology may be required to provide an early view on whether that warranty was accurate. These experts will also be able to assist in assessing the value of potential claims.
Share Purchase Agreements (SPA) will often set a time limit for warranty claims to be pursued; typically 1 or 2 years from the date of purchase. It is therefore vital that purchasers are aware of this deadline and seek legal advice on potential claims as soon as a potential breach is suspected.
Where a seller has breached a warranty, the purchaser will be entitled to recover damages from the seller. Most commonly, damages will be calculated as the difference between the value of the business if the warranty had been true, i.e. the seller had not breached the warranty, and the value of the business taking account for the undisclosed breach. In both scenarios, the company is valued at the date of completion. This avoids any potential impact market fluctuations might have had on the value of the company prior to and post completion.
Because the damages assessment is based on the impact the warranty breach had on the value of the business, expert accountancy evidence plays a vital role in any warranty dispute. Typically, the seller and purchaser will appoint their own accounting experts who will each offer an opinion as to the correct measure of damages. Where claims proceed to trial, the Judge will hear evidence from both experts and will decide which assessment should be preferred.
Limitations on claims
SPAs will often place a lower and upper limit on claims. For example, it is common for SPAs to exclude claims worth less than a few thousand pounds, known as ‘de minimis’ claims. Equally, SPAs will limit the damages recoverable for a breach of warranty to the price paid for the business.
As with any monetary claim, it is important to consider whether the defendant is capable of paying any damages awarded before taking legal action. There is rarely any point in securing a court judgment if the seller is insolvent. Furthermore, breach of warranty claims are not inexpensive to pursue due in part to the need for expert evidence and so your opponent’s ability to pay the majority of your legal costs should also be a primary consideration before proceedings are issued.