When you are selling shares in your business, the buyer will want you to provide warranties to guarantee the value of the shares. Seller warranties (also known as vendor warranties) are promises you make about the shares. For example, that you have disclosed all relevant matters at the time of sale. If you breach a warranty, it may allow the buyer to claim damages or walk away from the sale.
However, you do not want to give away too much. This article describes some simple ways that a seller can limit their liability for warranty claims made by the buyer.
If the buyer has drafted the warranties, they will usually be fairly extensive and catch-all. Therefore, in this case, it is important that you read them carefully, with input from your legal adviser. Once you agree to the sale, you will be promising to uphold those warranties.
If the warranties are not accurate, you should raise the issue before signing the share sale agreement. You will need to do this in writing so it is on record.
Furthermore, ensure that you agree with the warranties from the point of signing the contract, not just at the final completion and share transfer date. If any issues arise between signing and completion, you will need to raise them.
Limit the Warranties
You do not need to give a warranty regarding every single matter concerning the shares. Instead, limit the seller warranties to those issues that will have a significant impact on the value of shares. This also means writing warranties as specific as possible. It is best to avoid broad catch-all or forward-looking statements.
Another way to limit the scope of the warranties is to limit them to awareness. You can do this by including statements such as “to the Seller’s best knowledge” or the “the Seller is not aware”.
Make the Share Sale Agreement Final
You are likely to have made representations regarding the sale when you first propose to sell the shares and during negotiations. However, the share sale agreement should specify that only those seller warranties in the agreement apply. Furthermore, the agreement should also state that it forms the entire and complete agreement regarding the sale and that the buyer has acknowledged this.
Disclosures Qualify Warranties
Any disclosures that you make regarding the share sale should qualify the warranties that you give. That means if a disclosure suggests that a warranty is not 100% correct, that this ok because you have already disclosed this to the buyer. For example, if disclosure indicates that the business may have lower expected profits than initially assumed at the start of negotiations, the written disclosure you provide should state that it affects the relevant warranties. This way, the buyer will not be able to rely on those initial representations.
You should tightly control the disclosure process to keep track of disclosures. You can do this by either:
- keeping a list of the documents disclosed;
- conducting disclosure via a data room; or
- preparing a separate disclosure letter that confirms the disclosed matters that will qualify the warranties.
The buyer should not be able to make a claim where they were already aware of a matter from disclosure or from publically information that was contrary to a warranty. Therefore, the share sale agreement should state that the buyer acknowledges this. Keeping control of the matters disclosed from the outset will prevent any disagreement arising later down the track about what was disclosed and what the buyer was aware of.
Add Damages Caps and Claim Thresholds
Include a cap on the damages that the buyer can claim for a breach of warranty. There may be different caps for different matters the warranties deal with.
For example, an important warranty is that you have ownership of the shares and so are able to transfer the shares to the buyer. This warranty will usually provide that the buyer is entitled to damages of 100% of the purchase price if this turns out to be false. However, for other warranties that are not so important, damages may be capped at as little as 5% of the share purchase price. This is open to negotiation.
It is also reasonable to try and exclude claims below a certain monetary threshold as you do not want a buyer claiming for trivial issues. You may also want to specify that the buyer can only make a claim where the total value of all claims reaches a certain monetary value.
Specify a Time Limit for Claims
You do not want a buyer to be able to claim a warranty decades after the sale. Therefore, you should request a specified warranty period during which claims can be brought. This period is usually between one to two years.
Consider Your Insurance Options
You should make sure that if the buyer can claim under insurance for an issue related to a warranty breach that they do so first before making a warranty claim. Otherwise, they will be able to ‘double-dip’ — claim both the warranty and the insurance.
You may also suggest to the buyer that they take out buyer-side warranty insurance to meet claims they need to bring. This may give them extra comfort. You may have to pay for this insurance. However, this may be worthwhile if it gives you a clean exit, without having to worry about paying for warranties.
You might also consider getting seller-side warranty insurance instead, but warranty insurance is usually bought by the buyer. Of course, the insurance may not cover all warranties, so you should read the policy carefully.
When you sell shares in your business, you will need to provide seller warranties to the buyer. However, it is important to limit your liability. Otherwise, you may end up paying for issues that are truly the buyer’s responsibility.
If you need assistance with limiting your seller warranties in a share sale agreement, call LegalVision’s sale of business lawyers on 1300 544 755 or fill out the form below.
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