The importance of warranties
When independent practitioners are buying or selling a business, half of the agreement for the sale will be a schedule of warranties. If you are prepared to answer them before you go to market, the higher the value your business is likely to be, because each warranty you cannot confirm, is money off the price.
First published in Independent Practitioner Today in September 2019
Why have warranties?
Every business has a history and will have entered into many and varied arrangements, and things may have gone wrong which they have patched up and moved on. It is vital that when you acquire a business, you find out as much about its history as you can, so you know what you are inheriting and what you will be liable for.
Due diligence is a very important part of the process of buying or selling a business, and the buyer will ask to look through all the records it would expect the seller to have kept.
Although a buyer trawls through the past accounts, contracts, employee contracts, information about their premises, claims and reports, these will not tell you everything.
The law in England and Wales (and most Anglo Saxon jurisdictions) follows the maxim “caveat emptor” or “buyer beware”. This means that the buyer takes the risk on any purchase. The way to rebut that risk is by requiring the seller to make representations, and then if any of those representations prove to be wrong, the buyer would claim for damages for the losses which resulted. Warranties are those representations.
Warranties are statements of information which you warrant are true. If they prove not to be true, the buyer can claim against the seller for any losses which result. To guard against this the seller will ‘disclose’ against warranties by making statements which qualify the statement made in the warranty.
The temptation for any seller is to state that the warranty is true ‘so far as it is aware’, but proving awareness can be difficult, so it is important that that what is meant by that is defined clearly. The buyer does expect that the seller makes proper and thorough enquiries and that the seller knows its business sufficiently well, as opposed to relying on the knowledge of the manager of the operation at the time of the sale.
An example of a warranty might be: “The Seller has maintained licences in respect of all intellectual property deployed by the business.”
In this example, if the seller decided not to renew certain licences as it thought it would be selling very shortly but was still using the subject matter of the licence, it would have made a misrepresentation. If it didn’t inform the buyer, then the buyer can be expected to make a claim against the seller if a claim was made against the buyer after the acquisition for not having the licence at the time.
If however the seller informed the buyer, then the purchase would have been made with the full knowledge of the situation, and the buyer would have no claim. This can become particularly important where a claim by a member of staff has been made but not disclosed.
Therefore, an important second part of warranties is disclosure. This is the procedure by which the seller informs the buyer that there are issues which mean that the warranty is not totally true, and so it is qualified.
To avoid claims for insubstantial amounts as a result of breaches of warranties, there is usually an amount specified below which no claim can be made (unless it is a series of small claims). Also, the seller may put a maximum amount of claim which is often the purchase price, so no claim can be made which exceeds the purchase price. This limit can be exceeded. For example, if it is found that the ground had been contaminated by the operations of the seller, the clean-up costs can be very substantial, so you may carve out some losses from the limitations.
The seller may also put a time limit on claims under the warranties, which may be very short – one or maybe three years. However, certain warranties and indemnities will be excluded, such as tax warranties, as HMRC may make a claim up to four, and in some cases six, years after the end of the relevant tax year.
It is perhaps worth bearing in mind that warranties and indemnities are only as good as the seller giving them. A seller may distribute the sale proceeds very soon after the sale by paying a dividend to all its shareholders. Unless the shareholders are also party to the sale and purchase agreement, indemnities and warranties may be worthless, however well drafted they are.
However, the part they play in allocating risk in a sale should not be under estimated, and even the negotiation of warranties and disclosures serve to unearth issues. If the seller is resistant to give a warranty or attempts a broad and general disclosure, then you should look to see what is being hidden.
If you are preparing to sell your private healthcare business, look through some business warranties as far in advance as possible, and then attempt to meet the requirements of each statement by the time you put the business on the market. If you are buying, think ahead of the matters you want to confirm, and make a note of statements of assurance made in negotiations so that they are included in the warranties.
Justin Cumberlege is a partner in the corporate team of Hempsons. He can be contacted on 020 7484 7575 or email him at J.Cumberlege@hempsons.co.uk