Business

Selling a company?...Beware the warranties

Friday, February 01, 2013    

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As with any arms length sale transaction, the overriding objective of the seller will generally be to negotiate and obtain the highest price possible in order to maximise his/her return on investment made in the company. However, a properly advised seller will be equally concerned to limit his or her exposure to post-sale liability following completion of the transaction.

In this regard, the prudent seller will carefully consider which, if any, warranties he/she is prepared to give to the purchaser as part of the sale agreement.

Warranties are contractually enforceable "promises" made by the seller of a company to the purchaser dealing with the company's condition at the time of sale. They are intended to give the purchaser a right of redress against the seller of the company should undisclosed problems emerge later on which adversely affect the company's value.

For example, two common warranties which a prudent purchaser will always insist upon are that the company is tax compliant and that it is not involved in any contentious financial dispute. If a seller were to give these warranties at the time of sale, and then the company were to be pursued subsequently for outstanding taxes which were not disclosed or be sued as a result of an undisclosed dispute then the purchaser would have a right to sue the seller for these losses. The seller's exposure under the warranties is amplified where there is an agreement to accept deferred payments. This is because if the purchaser fails to make the future payments and the seller brings a claim, the purchaser can and often does attempt to bring a counterclaim alleging breach of warranty to muddy the waters.

The bottom line is that the seller must ensure that he/she is comfortable with all the warranties as included in the sale agreement and that they are all correct - even if the purchaser is not pressing for evidence of accuracy at that stage. If the seller is not comfortable with any of the warranties the issues must be addressed prior to completion of the deal. The properly represented seller will seek to include provisions to limit his/her exposure under the warranties. Such provisions may impose a time limit for bringing a claim under the warranties and exclude minor claims below a specified value thereby capping total liability for breach of warranty.

Finally, the prudent seller will provide the purchaser with a standard disclosure letter prior to completion of the transaction. The disclosure letter is the seller's opportunity to disclose to the buyer any matters which qualify or contradict the warranties contained in the sale agreement. The seller's potential liability for a breach of warranty is reduced to the extent that a matter is fairly disclosed. The form and format of disclosure letters has evolved over time and has become fairly standard. The letter usually includes a number of "general disclosures" and also a series of "specific disclosures". It also normally has attached to it an indexed "disclosure bundle" containing the various documentation cross-referenced in the letter itself. The general disclosures cover matters that appear on public records and which it is fair to expect the buyer check with respect to the company, including, for example, property searches and a search of information held by Companies House and the Jamaica Intellectual Property Office. The specific disclosures cross refer to and qualify the warranties in the sale agreement. Where the seller knows that a warranty in the sale agreement is inaccurate then the seller should make a specific disclosure to the buyer to explain why that is the case. Should the purchaser proceed with the company acquisition notwithstanding the matters disclosed in the disclosure letter, then going forward the purchaser will not have a legal right of redress against the seller in respect of such matters.

Randolph Cheeks is founding Principal of the boutique business law firm Cheeks & Co. He may contacted via email to clientsupport@cheeks-co.com

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