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Seller Protection Provisions

22nd February 2017

When a buyer acquires a business or shares in a company it is common for the buyer to seek various warranties and indemnities about the business and its affairs. These give the buyer comfort that it will in fact acquire what it is expecting to acquire and if it does not ensure it has recourse against the sellers. Warranties are statements about the current situation and past activities of the business or company and can be very detailed. For example, it is normal for the business/company accounts to be warranted as giving a true and fair view, that the business/company is not being sued or investigated and that it has complied with relevant laws etc.

Of course no business is perfect and there will be exceptions or qualifications that the sellers will need to make to the warranties. This is usually done in a disclosure letter where various general and specific disclosures are set out with the intent of giving the buyer the same level of knowledge about the business/company as the sellers have. Many disclosures will not be a cause for concern and are taken on as part of the rough and tumble of business life. Some however may be more serious, for example litigation or public authority investigations. In these circumstances the buyer will seek specific “indemnities” whereby the sellers agree to satisfy all losses and costs that arise from the subject matter of the indemnity.

The negotiation of the terms of the warranties and indemnities can, quite understandably, become quite complex and none more so than the provisions aimed at limiting the sellers’ liability.

It is common practice for the parties to an acquisition agreement to negotiate various financial and other limitations on the sellers’ liability for warranty, indemnity and tax covenant claims. Whether these limitations will apply to all three types of claims will usually depend on the negotiating powers of the parties involved, the specific details regarding the claim and the points listed below. It is also important to note that most tax covenants will contain their own limitations for claims made under the tax covenant. Therefore, it is important to check these alongside the limitations included in the acquisition agreement to ensure there are no inconsistencies.

The sellers of a company/business will want to limit their liability for claims under an acquisition agreement for a number of reasons, including:

  • to ensure claims are limited to a certain amount so they know what their maximum liability will be;
  • to ensure claims are not left open-ended in terms of the time frame within which claims can be brought. For example, a tax related claim can normally only be brought during the 7 year period following completion; and
  • to ensure that the buyer is obligated to observe the common law duty to mitigate its loss.

The sellers will also want to make sure that any information they disclose or is deemed disclosed to the buyer limits their liability for any claims brought under the warranties.

On the flip side the buyer will want to ensure that it is adequately protected and will not want to take on any unnecessary or unreasonable risk.

The following additional limitation provisions are also normally negotiated between the parties:

  • provisions requiring the buyer to seek recovery or reimbursement from a relevant third party (such as an insurer) before it can pursue a claim against the seller;
  • providing for claims to be reduced by amounts recovered from third parties where such recovery relates to the claim in question;
  • excluding liability for matters known to the buyer. This is linked to the disclosure point mentioned above, however, it is normal for the parties to negotiate whether the buyer’s knowledge (whether actual or construed) should limit a sellers’ liability;
  • excluding liability for claims that arise (or are increased) as a result of the buyer's voluntary acts;
  • giving the sellers control of the conduct of third party claims that may lead to a claim under the acquisition agreement.

Whether or not these limitations are included (and to what extent) will vary from transaction to transaction and will usually depend on:

  • the bargaining position between the parties;
  • the buyer’s and the sellers’ attitude to risk;
  • the extent of the buyer's due diligence exercise and the sellers’ replies to the buyer’s enquiries;
  • whether warranty and indemnity insurance is being sought;
  • the nature and complexity of the business being purchased;
  • whether any amount is to be held in escrow or if there is some form of deferred consideration which the buyer can use to offset any claims; and
  • the buyer’s future plans for the business.

Mundays’ corporate team has vast experience in acting for both sellers and buyers. We will be able to advise you on the above points and assist you in bringing your transaction to a satisfactory conclusion.

For further information please contact Howard White, an Associate in Mundays’ corporate and commercial department.

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