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Sales of Shares and Businesses: Disclosure Letters and Warranties

Monday, 6 February 2012

When a buyer agrees to purchase a company from a seller the terms of that deal are captured in a contract often prepared by the buyer's solicitor. Within that contract two things operate to help define the allocation of risk of claims between buyer and seller after the purchase is completed. The first of these is warranties, which we have talked about in more detail elsewhere. The second is the Disclosure Letter.

Warranties and Disclosure Letters

Warranties are promises made by the seller contained within the contract of sale. The promises will relate to the state of the company or business asset being sold. For example, a seller may warrant that a company is not involved in any unresolved litigation. Warranties work to 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. The buyer can sue if a warranty proves untrue thus the effect is to transfer some of the risk of the transaction back to the seller.

In contrast Disclosure Letters refine the scope of warranties by facilitating the disclosure of certain information by the seller during the due diligence process. The idea is that the seller cannot be successfully sued upon warranties where the buyer's complaint arises from a matter disclosed in a disclosure letter. In this way warranties may be qualified limiting the amount of risk transferred back to the seller.

The Disclosure Letter is usually accompanied by documentation to support the excepted items disclosed by the seller. An identical copy of this documentation is retained following completion of the transaction.

Risk Allocation

Warranties and the Disclosure Letters play an important role in the due diligence and negotiation process preceding completion of a business sale or the sale of shares in a company. Once the process is complete the two documents map out how the commercial risks are allocated between the buyer and the seller. Needless to say, it is of critical importance to both parties that they receive sound professional advice and, in the seller's case, to ensure that no warranties are given which are either inaccurate or inadequately qualified by a disclosure letter. The result could be a substantial claim for damages against the seller.

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