Are you buying a business? Whether you are buying shares in a company or purchasing its assets... the general Latin common law principle "caveat emptor" applies. This translates as "let the buyer beware" and places an onus on the buyer to conduct the necessary due diligence in order to understands what it is purchasing before completing the transaction. This means there is no obligation on the seller to disclose any issues with the business.
As a result, when buying a business, a buyer will want some extra assurances from the seller to mitigate against the risk of undisclosed issues. In these circumstances, the buyer can ask the seller for a warranty.
What is a warranty?
A warranty is an undertaking provided by the seller regarding the state of affairs of the target company or business, including the existence and extent of any liabilities. It is not always possible for the buyer to find all likely issues with the business during the due diligence process, so the purpose of the warranty is to provide the buyer with a degree of comfort that if an undisclosed issue later materialises, there will be a mechanism for the buyer to protect itself financially. Examples of warranties could include statements about the business' financial position, accounts, commercial contracts, compliance, property and tax. If a warranty is untrue, a buyer can claim damages on the basis of breach of contract.
It is important to recognise that this is different to an indemnity. An indemnity clause is an enforceable promise to reimburse the buyer in respect of a future liability (for example, for a loss suffered in the future). For instance, a seller might indemnify a buyer for an unpaid debt to the business in the event that it turns into a bad debt.
Breach of Warranty
Determining whether a warranty has been breached is rarely an easy task. It is therefore recommended that you conduct a thorough investigation as soon as possible and seek the appropriate experts' advice to assist you. Which experts are involved will depend on the specifics of each case, as well as the alleged warranty breach.
If it is determined that a warranty has been breached, then it is likely to give rise to a breach of contract claim. This means the buyer can claim damages for the losses it has suffered.
The industry in which the business operates and the overall consideration will often be a driving force in the duration of a warranty. In some industries any skeletons that make be lurking can take longer to be identified and, therefore, advice should always be taken in relation to a suitable warranty period.
The industry in which the business operates and the overall consideration will often be a driving force in the duration of a warranty
Recent Case Law
On 8 May 2024, the Court of Appeal handed down judgment in Drax Smart Generation Holdco Ltd v Scottish Power Retail Holdings Ltd [2024] EWCA Civ 477.
The facts, in summary, were that Scottish Power (the Seller) sold its shares in VPI Power (the Target Company) to Drax (the Buyer). One of the assets of VPI Power was a site in Kent which had the potential for development of a new power station. In order to be able to use the site, it would have to be connected to national electricity grid. As such, a warranty was included in the SPA to ensure that VPI Power was sold with the benefit of an option to acquire an easement over a piece of adjacent land. This easement would allow the site to connect to the national electrical grid. After completion, it was discovered that Scottish Power did not have the benefit of that option nor any easement over the adjacent land.
Drax claimed breach of warranty and for an indemnity of its losses. Scottish Power applied for summary judgment on the basis that (i) Drax had not notified Scottish Power of the warranty claim in accordance with the notice of claim provisions in the SPA, specifically the provision "in reasonable detail the nature of the claim"; and (ii) that the indemnity claim was out of time. At first instance, the Judge found in favour of Scottish Power in respect of the warranty claim due to the fact that the phrasing compelled the buyer to specify its loss by a reduction in the value of VPI's shares. In respect of the indemnity claim, the High Court found in favour of Drax. Both points were appealed, and the Court of Appeal found in favour of Drax for both the warranty and indemnity claims. Lord Justice Males commented on the purpose of notice of claim clauses in SPAs and provided insightful guidance for future disputes:
"Whether a notice is sufficient to satisfy the requirements of any given clause must depend primarily on the language of the clause. Commercial parties are free to impose whatever requirements they wish. However, where they use broad and general terms such as 'the nature of the claim' and 'in reasonable detail', those requirements should be interpreted in the light of the commercial purposes of such clauses, including those identified in Dodika. It is important that Notice of Claim clauses should not become a technical minefield to be navigated, divorced from the underlying merits of a buyer's claim. While a seller's interest will always be to knock the claim out if it can on the technical ground that the notice is insufficient, courts should not interpret such clauses as imposing requirements which serve no real commercial purpose unless compelled to do so by the language of the clause."
Key take aways
One of the key take aways for buyers is the importance of bringing claims within the warranty period and ensuring they comply with the SPA notice provisions. It is also important to recognise the difference in operation of a warranty clause and an indemnity clause. A warranty is typically a contractual assurance from the seller that the target company is in a specific state i.e. compliant with current laws, whereas an indemnity is an enforceable promise and if broken, the seller must reimburse the buyer for the particular loss suffered, whether the buyer suffered that loss or not.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.