The Due Diligence Procedure
Warranties & Indemnities
In a business acquisition, (whether an asset or a share acquisition), there will almost always be an element of risk for the buyer.
To try to understand the extent of any risk(s), the buyer may raise a number of enquiries (‘due diligence enquiries’) in respect of the affairs of the target business and the seller will be asked to reply to each of the enquiries, often with documentary supporting evidence.
Depending on the replies provided, the buyer may seek protections within the Sale and Purchase Agreement; namely warranties and indemnities.
Warranties are assurances given by the seller with regard to the affairs of a business.
For example; the seller may provide a warranty, assuring the buyer that the seller has complied with all obligations imposed on him by all statutes, regulations and codes of conduct and practice relevant to the relations between him and his employees.
Of course, the buyer would not want to have to incur the time and expense after purchasing the business in defending a claim from an employee due to the seller having not complied with his obligations to the employees.
If the seller breaches a warranty, the buyer may seek an award of damages by the court.
However, the buyer will not generally be able to claim for breach of warranty where such matter has been sufficiently ‘disclosed’ against. It is usual for the seller to disclose (amongst other things) the seller’s replies to the buyer’s due diligence enquiries.
The disclosures will be contained within a Disclosure Letter (sent by the seller and acknowledged by the buyer).
An indemnity is essentially a promise by the seller to reimburse the buyer for losses suffered by the buyer under a specific circumstance or specific circumstances.
For example; the buyer may request that the seller indemnifies the buyer against all costs and expenses incurred by the buyer from any claim raised by an employee due to the acts of the seller prior to completing the sale and purchase of the business.
The ‘value’ of potential future claims (if any) will not always be known when committing to purchasing a business, which is why indemnities are useful for the buyer to have in a Sale and Purchase Agreement to protect against future risks.
However, from the Seller’s perspective, depending on whether there are any limitations on the indemnities, the seller may be being asked to (in effect) sign an ‘open cheque’ as indemnities cannot be disclosed against.