The purpose of warranties in a share purchase agreement is often misunderstood by purchasers. There are a number of factors to consider before requesting or relying on a warranty in your agreement. Here are our tips for purchasers entering into a share agreement.
1. Warranties are not a substitute for proper due diligence.
Warranties given by a vendor will not guarantee you protection if things go wrong. For example, even if there is a breach of warranty, there could be any number of reasons why you might be unwilling or unable to enforce it. Litigation is inevitably expensive. And even if you are successful in making a claim, there is never any guarantee that the seller will be able to pay the damages they owe.
The best way to minimise the risk of your purchase is to invest the time in getting to know the business you are purchasing into, prior to the sale. Structured due diligence is the best way to achieve this and to ensure that you understand what you’re buying. (Read more about this in our due diligence guide for investing in a private company.)
2. Consider warranties that might be unique to your arrangement.
It is not difficult to find a generic set of warranties for a purchase agreement. Indeed, it is usually easier to use a boilerplate set of warranties instead of developing something specific to your transaction.
The problem with this approach is that generic warranties may not deal appropriately with the elements of your transaction that are most important to you. Without stepping back and thinking about exactly what it is you are buying and what the unique risks are, you run the risk that the warranties in a generic share purchase agreement may not give you the protection you are hoping for.
3. Avoid asking for too much.
Similarly, the use of a long list of generic warranties can ultimately do more harm than good. Inevitably, the seller will seek to limit the warranties as much as possible. Sending the seller a long list of generic warranties is only likely to erode goodwill between the parties and consume more time (and legal fees) while the parties negotiate an agreement that they are prepared to sign.
Being clear about your priorities from the outset, and employing a set of warranties that focuses on your priorities, is likely to speed up negotiations and avoid unnecessarily wasting time and money.
4. Expect the seller to seek to qualify its liability.
Naturally, there is a tension between the warranties that you will want, and the risk and liability that the seller will be prepared to accept.
For example, the seller will likely resist absolute warranties, seek to limit its liability, and attempt to limit the time within which you can make a claim for a breach. The seller will also seek to rely on the material that it discloses to you during the due diligence process to limit its liability. The seller may also wish to qualify certain warranties so that they only apply ‘to the best of its knowledge’.
There is nothing unusual about these kinds of limitations appearing within a share purchase agreement. They should be something that you should be willing to accept if the qualifications are reasonable in the circumstances, including the price you are paying. This is because any sale involves a conscious transfer of risk and reward from the seller to the buyer, and you cannot expect the seller’s liability to be unlimited and indefinite.
5. Be firm about the things that matter.
Provided you understand the nature of the thing you are buying, you will be well equipped to identify the key risks and how to mitigate them. This may be achieved through warranties and indemnities. However, for a share transaction to be successful, you will also need to identify the areas that you are willing and able to compromise on.
While warranties offer some protection in a share purchase agreement, these protections can be limited, and may not necessarily be the best way to mitigate the specific risks that apply to your transaction. What is most important is to be informed. Take the time to consider the full array of risks based both on the information that you have been provided as well as making your own enquires.