After years of hard work building up a business, the prospect of selling it on to another company or the current management team will be the light at the end of the tunnel. Unless you are a serial entrepreneur, a more leisurely life is ahead when the stresses and strains of running a business will be behind you.

While the purchaser should have a good idea of the business that they are buying, the last thing they want is for some nasty skeletons to appear from the cupboards, while you are enjoying your new-found freedom. For example, they would not want to discover a problem over rights of access or a major dispute with a key supplier which could disrupt their ability to carry on the business.  Consequently, they will demand warranties from the seller.

‘Alongside the matter of the price for the business, the issue of warranties will be one of the biggest concerns to anyone selling a business’ says Alec Brooks, Partner and corporate specialist with Lamb Brooks in Basingstoke. ‘The buyer has no legal protection in respect of the assets and liabilities which are being purchased; so, representations made by the seller in the warranties provide important clarity on the target company’.

What is a Warranty?

During the sale process, you will need to disclose information to the buyer via due diligence. It will be necessary to give some form of written statement, a warranty, which gives the buyer some contractual protection over the value in the business. This information will relate to the target company such as the accounts, details of employees, premises and the commercial contracts with suppliers and customers, compliance and all other matters relating to the business.

For example, you may give a warranty as to the status of a commercial contract which you believe will deliver a specific financial outcome. If this is inaccurate or false, then the buyer could claim for breach of warranty if they can prove the breach and quantify the loss.

Types of Warranties

The extent and nature of the warranties that a seller will be asked to enter into is driven by both the structure of the target business and the value of the target. As a general rule of thumb, the greater the value of the target company or the more complex the nature of the business the more extensive the level of warranties will be.

There are a number of common areas that warranties will focus on and these include:

• corporate warranties which cover the share structure and identify the legal and beneficial ownership of the shares;

• employment warranties which cover the number of employees in the business, their length of service, any employment breaches and ongoing employment investigations;

• property warranties identify if the business owns specific buildings and on what basis, and there may also be warranties on the condition of the buildings;

• litigation, regulatory and environmental warranties are often included to ensure that the business has not breached any regulation or environmental measure and that if litigation is ongoing a warranty as to the status of that dispute and the potential prospects of success;

• contractual warranties frequently appear in transactional documents and cover both supply of goods and services but also agency and distribution agreements; and

• financial and tax warranties cover both the company accounts and also the company’s tax position.

In regard to potential tax liabilities, this is one area in which it is likely your solicitor will direct you to an accountant specialising in Tax for support with these bespoke warranties.

Mitigating and Managing Warranties

ggYou will only be able to give a warranty insofar as you are aware of a specific set of facts. Often the first draft document that the buyer sends over will contain an array of warranties, some of which may not be relevant to the nature of your company. Your solicitor will be able to remove the irrelevant warranties at this stage.

For the warranties which are relevant to your business; your solicitor can draft specific wording into a contract to limit liability, for example to a certain percentage of the purchase price. Alternatively, it may be appropriate to insist that any claim follows a prescribed process for commencing a claim and within a set timeframe.

You will need a great deal of legal support during the transaction. Warranties are extremely technical; and, it is not uncommon for a solicitor to go through each warranty line by line to ensure that a seller is not exposed to the risk of future litigation because something has not been disclosed against a warranty.  This can be time well spent if it avoids future claims and the legal expenses of a dispute – never mind the disruption to your retirement!

For advice on warranties or selling your company please contact Alec Brooks, Partner on 01256 844888 or email alec.brooks@lambbrooks.com

The contents of this article are for the purposes of general awareness only. They do not purport to constitute legal or professional advice.  The law may have changed since this article was published.   Readers should not act on the basis of the information included and should take appropriate professional advice upon their own particular circumstances.