A buyer shoulders most of the risk associated with the acquired business once a deal is completed. However, before this happens, buyers seek contractual assurances and protections against problems with the target company that are identified or arise prior to the deal closing. A buyer can seek damages in the event of a breach of these provisions which can impact a seller’s sale proceeds.
Here is what every seller needs to know in order to keep more of the sale price where it belongs – in their pockets.
Warranties: promises and assurances
Warranties are contractual promises made by the seller about the state of the business. These statements cover a range of areas from ownership and financial solvency to compliance with laws, the status of assets, operational matters and the absence of undisclosed liabilities.
- The seller’s goal: Sellers usually aim to limit warranties so that they do not cover the future. The extent of certain warranties may be qualified by seller awareness, duration or materiality.
- The buyer’s protection: If a warranty turns out to be false following the acquisition, the buyer can claim damages based on the impact on the value of the acquired interests.
Disclosure: a seller’s shield against a warranty claim
Disclosure is the process where the seller informs the buyer of specific facts or circumstances that might qualify or contradict the warranties being given.
- How it works: The seller provides the buyer with details of any known issues which would make a warranty untrue. For example, if the seller warrants that the target has not taken on any third-party debt, but the target has recently entered into a bank facility agreement, the seller would need to provide sufficient detail of the loan.
- The disclosure letter: Formal disclosure is typically documented in a disclosure letter from the seller to the buyer. This letter contains both general disclosures (e.g., publicly available information or the contents of the data room) and specific disclosures that directly relate to individual warranties.
- The impact: If a disclosure exercise is done correctly, the seller may be shielded from a breach of warranty claim because the buyer is treated as having been aware of the disclosed matter before it completed the deal.
Indemnities: a guarantee against known losses
Unlike warranties, which cover general aspects of the business, indemnities address specific, known risks or potential liabilities.
- What they are: An indemnity is a commitment by the seller to reimburse the buyer for a specific loss, on a dollar-for-dollar basis, without the need to prove fault or breach of contract.
- When they’re used: Indemnities are usually reserved for covering specific liabilities that the buyer has identified during due diligence or through the disclosure process but that haven’t yet fully materialised. A classic example is ongoing litigation where the final outcome and costs are still uncertain. In such a scenario, it may be appropriate for the seller to indemnify the buyer against any future amounts that may be payable to settle the litigation.
