5 Types of Warranties in a Mergers & Acquisition Transaction

In Short

• Warranties provide assurances from the seller to the buyer regarding the condition of the business, such as solvency, legal disputes and financial position.

• Common types of warranties include the accuracy of information, the absence of litigation, and the company’s power and authority to enter into the transaction.

• Warranties help allocate risks in M&A transactions and protect the buyer from undisclosed liabilities or financial discrepancies.

Tips for Businesses

When entering into an M&A transaction, ensure that the warranties are clearly defined and tailored to the specific circumstances of the deal. Regularly review and update these warranties to reflect any changes in the company’s situation. Seek legal advice to ensure that the warranties adequately protect your interests and comply with relevant laws.

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Table of Contents

• Common Clauses Which Affect Warranties
• 5 Types of Warranties in a Mergers and Acquisition Transaction
• Key Takeaways
• Frequently Asked Questions

One of the key areas of controversy when finalising a merger and acquisition transaction is the warranties provided by each of the parties. A vendor usually seeks to provide the minimum warranties possible to limit their potential liability, while the purchaser often asks for extensive warranties from the vendor to protect them against potential liability in the transaction. This article explores some the most important warranties to consider and their application.

Common Clauses Which Affect Warranties

Warranties give rise to claims if either party breaches them. However, claims against warranties are usually subject to limitations. For instance, a time limitation on a warranty will protect the vendor by limiting the purchaser. It limits the purchaser’s ability to make a claim for breach of warranty within a specified time frame. It is also common for the parties to include a clause stating that each of the warranties is separate and independent. This means other warranties cannot limit it.

Another way a vendor may seek to limit the warranties is through the inclusion of qualifications. For example, if a warranty may be qualified to the extent it had been disclosed (in due diligence material or in publicly available information), or is within the knowledge of the purchaser, then a purchaser will seek to reduce the level of vendor qualifications in order to ensure that, in the event of a breach of warranties, its claim will not be unduly limited.

The contract will also typically contain provisions where the purchaser acknowledges that they will not rely on any statements which the parties do not expressly include in the contract.

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5 Types of Warranties in a Mergers and Acquisition Transaction

In large scale transactions, the parties will include warranties in a schedule to the contract and can span over many pages. Five of the most common warranties that parties include in larger transaction contracts are:

1. Solvency

The purchaser needs to make sure that the vendor warrants that the company they are selling (Sale Company) is not:

• Insolvent;
• Subject to voluntary administration; and
• Has not stopped paying its debts.

The solvency requirements may also extend to the vendor itself. The purchaser should also address the following solvency issues:

• That a third party has not presented or threatened the Sale Company with winding-up or dissolution;
• That the court has not appointed a receiver, liquidator or administrator;
• That the Sale Company has not entered into arrangements for the benefit of the vendor’s creditors; and
• That the court has not issued a writ of execution against the vendor or the Sale Company.

If the vendor refuses to provide such a warranty, this should be serious cause for concern for the purchaser. A lack of solvency can mean the entity is not worth its purchase price or there are significant debts that the vendor has not disclosed.

2. Litigation

The warranties will also usually include a provision relating to litigation. It guarantees that the Sale Company is not a party to any:

• Investigations;
• Prosecution;
• Litigation;
• Legal proceedings;
• Any other form of dispute resolution process; or
• Governmental proceedings.

It is a warranty that there is nothing litigious which could affect the liability and debt of the Sale Company going forward.

3. Power and Authority

Merger and acquisition contracts will always include a warranty relating to power and authority. It sets out that each party’s execution and performance of the agreement:

• Complies with its constitution;
• Does not constitute a breach of any law or obligation; and
• The parties have obtained all the necessary authorisations to enter into the agreement.

It may also include clauses requiring the parties to acknowledge that they:

• Have the full power and capacity to enter into the agreement; and
• Are validly incorporated in their places of incorporation.

4. Accuracy of Information

The purchaser will want to include an ‘accuracy of information’ warranty if the vendor has provided due diligence material. However, it is not uncommon for the vendor to be reluctant about providing this. This warranty typically provides that:

• All of the information the vendor has given to the purchaser is not misleading;
• The vendor is not aware of any information that they have not made available to the purchaser; and
• All forecasts and projections in respect of the business are reasonable, honestly held and been prepared with care.

This type of warranty places the burden on the vendor to be able to provide the above assurances. It is why the vendor often refuses to give this warranty. The vendor often requires that the purchaser acknowledges that it is satisfied with its enquiries before entering into the transaction. The parties can negotiate this warranty with some limitations. For instance, the purchaser may agree that the warranty is limited to the vendor’s knowledge of these matters.

5. Accounts

The purchaser may also seek a warranty from the vendor concerning the accounts of the business. The warranty usually sets out that:

• The vendor has prepared the accounts according to the relevant accounting standards and applicable laws;
• The vendor has prepared the accounts on a consistent basis; and
• The reports provided give an accurate and fair view of the financial position of the business.

It will also include that the accounts contain all the liabilities of the business and that since the date the vendor prepared the accounts, the vendor has conducted business in the ordinary and usual way.

The warranty may also include a provision stating that the vendor has not:

• Sold, disposed of or created an encumbrance of its assets over a specific amount; or
• Acquired assets over a certain amount (except in the ordinary course of business).

Key Takeaways

Warranties are a contentious but important part of a mergers and acquisitions transaction contract. The type of transaction and the value of the business can often change the type of warranties that the parties decide to include in the contract. In any case, they are there to provide the purchaser comfort in moving forward with the deal.

The five warranties discussed in this article are all warranties that you will typically find in the contract. A vendor’s willingness to accept the inclusion of particular warranties comes down to its knowledge of the risk within the Sale Company and its negotiating position.

Transactions can be complicated, and negotiations can be lengthy. It is crucial, particularly for large scale transactions, to obtain legal assistance to ensure your protection.

If you have questions, our experienced mergers and acquisitions lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1800 875 477 or visit our membership page.

Frequently Asked Questions