If you’ve never sold a business before the sale process can seem daunting. Sadly, those episodes of Suits or LA Law where people complete multi-million pound deals in a matter of hours by signing at the bottom of a single sheet of paper don’t accurately reflect the trials and tribulations of the average transaction.
In particular one area which can be confusing for a first-timer is the warranty and disclosure process.
What are warranties?
In a sale agreement, the seller will be asked to make a series of statements about the business being sold, for example that it is not involved in any litigation, that it owns all the assets used in the business or that none of its employees has resigned.
What’s the purpose of warranties?
Warranties have two key functions:
- They provide the buyer with a post-completion remedy if a warranty turns out to be untrue (for example, if in fact the business was involved in a piece of litigation). The buyer will be able to claim against the seller for any loss suffered
- Warranties are designed to extract information from the seller via the disclosure process
A sword and a shield
The warranties are the buyer’s sword, which they may use to attack the seller post-completion. The disclosure letter is the seller’s shield, which they will use to defend themselves against the buyer’s claim.
We can’t say that!
Being asked to make a series of statements about the business being sold, even when you know some of those statements aren’t true, can understandably make sellers nervous. “We can’t say that!” they exclaim as they read the warranties with an increasingly furrowed brow. Don’t worry, we tell them, the extent to which they are not true will be set out in another document – the disclosure letter.
Leaving the warranty in its original form and including matters which are inconsistent with those warranties in another document can make little sense to clients but it’s the convention of how deals are structured in the UK. Provided a matter has been adequately disclosed to the buyer in the disclosure letter, the buyer will not be able to claim against the seller for breach of the warranty.
Sellers need to understand, however, that simply referring to a particular matter or set of circumstances in the disclosure letter may not be enough to avoid liability for breach of warranty.
Spending time reviewing the warranties and considering the nature and extent of appropriate disclosures is one of the most important tasks a seller will do. Disclosures need to be as full and clear as possible. They should enable the buyer to make a reasonably informed and accurate view of the matter concerned and its likely impact on the target business. Only then will the seller’s shield work to protect it from liability for breach of the warranties.