Warranties and Indemnities in Share Purchase and Asset Purchase Agreements

The terms “warranties” “representations” and indemnities” are frequently used throughout the sale of assets or the sale of shares process.

Sellers will be warned of these during the course of the sale transaction and buyers assured that they will have the protection of warranties and indemnities contained in the asset or share purchase agreement.

Indeed, the majority of any sale and purchase agreement is devoted to these provisions, together with attempts to limit their application through time, setting a threshold or limiting amounts of recovery to a fixed sum, but how do the terms “warranty”, “representation” and “indemnity” differ and what are the implications of any differences?

Warranties

Warranties in share or asset purchase agreements tend to be broad in application.  They make a number of assertions about the status of ownership, employees and employment law, processes, condition of assets, accounting and operating systems.

If  a warranty is breached, the recourse available by a buyer for that breach lies in contract law and consequently, any buyer would need to show that they suffered loss as a result of that breach, and would have a duty to limit or mitigate their loss (for example aged stock may generate a return but not full value) or demonstrating that the loss suffered was not too remote.

So by way of example, if B sold to S an item of machinery for a £10,000.00, and warranted that it worked for a particular purpose, and S was unable to fulfil a particular contract because it didn’t work, B would not be able to sue necessarily for breach of warranty claiming £10,000.00 if that machinery could have been sold to a third party for say £5,000.00.  S could only sue B for £5,000.00 in this example.

Indemnities

Indemnities in sale agreements almost always arise around tax considerations.  In fact the bulk of share and asset sale agreements will contain a stand alone tax indemnity Deed which the buyer will be asked to enter into on completion.

Indemnities are generally limited to specific issues which arise through the due diligence phase of a sale and purchase transaction, for example, they may relate to a matter involving unsettled litigation, or a specific customer dispute which has arisen at the outset of the transaction.

Whilst it is possible to limit liability for breach of an indemnity as with a breach of warranty, generally, a seller will be more resistant because indemnities are likely offered as an assurance for an event or situation which is known about and which is likely to arise.

When claiming for a breach of indemnity, there is no need to show fault or show any breach; there is no obligation on the buyer to mitigate his loss and generally, it is harder to argue that damages are too remote to be recovered.  So, in the example above, had the buyer provided the seller with an indemnity that the machinery would work for a specific purpose, the buyer would have been able to recover the £10,000.00 and would be entitled to retain the machinery.

Representations

Representations appear very similar to warranties in a sale contract, but there are key differences; a breach of warranty as explained above gives rise to a contractual claim whereas a breach of representation, gives rise to a claim under the law of misrepresentation.

Ultimately, the differences between representation and warranty lies around the limitation period, whether or not a party can rescind the contract and how damages for breach are calculated.

In conclusion, taking advice when presented with an asset or share sale agreement is crucial to ensuring that a balanced agreement is entered into between buyer and seller and where both parties are aware of their potential liabilities.