In any sale of business, vendor warranties are typically the least understood provisions. Despite serious consequences if a vendor breaches these warranties (e.g. termination of contract and damages), many don’t take the time to go through these clauses carefully. We set out some common vendor warranties below to help you understand their importance.
Capacity and Authority
Before explaining what this warranty contains, let’s first distinguish between capacity and authority. Capacity is the ability to enter into the Sale of Business Agreement (SOBA), and authority is the right to enter into the SOBA. For example, in relation to capacity, where a company wants to enter into the contract, then the party signing on behalf the company must be able to do so. A company director, for example, has the capacity to enter into the SOBA. Authority differs to capacity. Whether a director can enter into the SOBA depends on, for example, shareholders and/or directors passing a resolution.
Although capacity is rarely an issue, company directors can sometimes overlook authority. For example, many smaller companies fail to undertake the proper procedures of calling a meeting and passing a resolution. Failure to do so technically means the company doesn’t have authority to enter into the SOBA, and consequently, not have executed the SOBA. Another example is where a company (or in this example, even where the vendor is an actual person), may be a trustee. As a trustee, it must ensure it has the power under the trust deed to enter into the SOBA. If it does not, then it means it could be sued by the beneficiaries of the trust.
Accuracy of Company Records
This warranty provides that all financial information and other general information the vendor provides to the purchaser of the business are accurate, and provide a “true and fair view” of the financial position and performance of the business. A vendor can, in most cases, give this warranty confidently provided a qualified accountant prepared the financial reports, and a strong team records the business’ operations.
Sometimes, this isn’t the case and more likely, the sale falls on the last day of the financial year and at least some of those company records are yet to be audited and properly checked. Unaudited company records still form part of the financial information and other general information provided under this warranty. A vendor will breach this warranty if this information is later found to be inaccurate. To avoid this, a vendor should include an exception or provide a more general warranty (i.e. less strict warranty) regarding these records.
Assets, Plant and Equipment
Does the vendor own the assets, plants and equipment, are they in good working condition, and can they sell them? Any decent warranty would also contain a provision that requires there to be no security against any of the assets, plant and equipment. For example for a specific piece of equipment, it can be a simple task of running a search against that item to determine whether a security is registered against it or not. However, an All Past and Present Property (All PaP) security could capture this piece of equipment. In other words, the equipment forms part of another security that will need to be released for this warranty – even if the security has no connection with this particular SOBA.
Importantly, assets don’t just mean physical items of plant and equipment. In the modern economy, the business’ customer relationship management (CRM) software can sometimes be just as (if not more) valuable than the manufacturing equipment used to make the profit. However, when it comes to these non-tangible assets, determining ownership can be less obvious. Expanding on the example of the CRM software, if a third party developed this software for the business, then there could be an issue of ownership. It may be a situation that the developer owns the software and effectively licences it to the business. The vendor cannot then give the warranty that it owns this asset.
We have set out a small handful of the types of vendor warranties a SOBA provides. The takeaway message from this is that neither the vendor nor the purchaser should take for granted these warranties. Although it may seem evident that the vendor has the capacity and authority to act, some basic digging might show this isn’t the case. A breach of warranty can result in termination of the SOBA and subsequent damages – so it’s important you understand before signing. Questions? Get in touch with our sale of business lawyers on 1300 544 755.