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Purpose of Warranties in the context of Acquisitions

Sunday, 5 February 2012

The law offers little protection to the buyers of a private business in the absence of fraud or misrepresentation. Most business people are familiar with the concept of caveat emptor, or 'buyer beware' in more modern parlance. However, difficulties arise in the purchase of businesses as going concerns where it may not be possible to identify all problems or potential issues impacting upon the value of the business. It is up to the buyer of a business to ensure that he has taken steps to protect himself as far as possible through contractual negotiation with the seller and in particular obtaining contractual warranties. Contractual warranties are central to the buyer's risk-management process in the sale and purchase of a business.

The Warranty Process

Once the basic terms of a business or company purchase have been agreed in principle, a buyer usually carries out extensive due diligence into the business or company to be acquired. The contractual documentation effecting the sale is usually drafted in conjunction with due diligence and the buyer should request the seller to give warranties in the sale contract. A warranty is a promise or assurance by the seller that specific facts in relation to the business are true. The buyer is entitled to rely on that promise or assurance and if the promise or assurance is untrue, the buyer can seek certain types of legal remedy against the seller. Often the remedy is a right to claim financial compensation.

Although warranties in a contract of sale can be very extensive, the buyer must still be able to justify the inclusion of each one. Sellers on the other hand will be hard pressed to avoid warranties altogether but are unlikely to agree to those irrelevant to the transaction.

The Purpose

Adding warranties to a sale contract can serve a dual purpose. Where a buyer requests certain warranties the seller is put on notice of a buyer's concerns prior to completing a transaction. Those concerns can then be openly negotiated and managed within the contract, reducing the risk of subsequent disputes. The primary aim of each warranty however, is for the buyer to gain protection regarding the information warranted by transferring risk (legal liability) back to the seller, who can be sued upon any contractual warranties which are false. Warranties impose legal liability upon the seller and provide protection to the buyer if statements made about the business are incorrect and detrimentally affect its value.

For more information on sale of business warranties or to discuss a potential business purchase or sale, please contact James Crighton via e-mail or by phone on 020 7611 4848.