Warranties, indemnities and disclosure letters

When a business is sold, the price is only part of the deal, as the seller also gives the buyer a set of promises about the business, and those promises decide whether the buyer can get some of the money back after completion. The warranties are the promises, the disclosure letter is where the seller qualifies them, and indemnities deal with specific problems that are already known about. Together with the limits on claims, they’re usually the most negotiated part of a share purchase agreement and an important part of an asset purchase agreement.

I negotiate these terms for buyers and sellers of owner-managed businesses, and I also present a course for other solicitors on the disclosure letter. Most of what’s on this page applies to both sides, so I’ve said where the position differs.

What warranties are

Warranties are statements of fact about the business, such as that the accounts are accurate, the tax has been paid, the main contracts are in force, the company owns its intellectual property and nobody is suing it. On a share sale there may be dozens of pages of them. If one turns out to be untrue and the buyer has lost money as a result, the buyer can claim damages, which are generally the difference between what the business is worth and what it would have been worth if the warranty had been true.

That measure is narrower than a claim for misrepresentation, which is why sale agreements usually say that the warranties are contractual promises and not representations that induced the buyer to enter into the deal. That doesn’t always work, as the courts will sometimes treat warranties as representations as well, depending on how the documents were drafted and signed, and I’ve written about when that can happen.

The disclosure letter

No sensible buyer will accept a seller who refuses to give warranties, so the seller protects themselves through the disclosure letter. It lists the ways in which the warranties aren’t true, and anything properly disclosed generally can’t be the subject of a warranty claim afterwards. If a warranty says there are no disputes and there’s an unhappy customer threatening to sue, the letter discloses it, and the buyer then decides whether to proceed, reduce the price or ask for an indemnity.

What counts as properly disclosed is where the arguments happen. Sellers want general disclosures, such as everything in the data room or everything on a public register, and buyers should usually resist those, as I’ve explained in why a buyer should refuse a general disclosure. Specific disclosures have to be fair, meaning set out in enough detail for the buyer to understand the problem and its likely size, and something mentioned in passing during due diligence isn’t automatically disclosed against the warranties.

For a seller, the disclosure letter shouldn’t be left until the final week. It takes time to go through every warranty with someone who knows the business, and a rushed letter is more likely to miss something a buyer could later claim for.

Indemnities

An indemnity is a promise to pay pound for pound if a specific thing happens, and it’s used for problems which are already known about, such as an HMRC enquiry, a claim by a former employee or a product that might need recalling. Because the buyer knows about the problem, a warranty won’t usually help, as the seller will have disclosed it, so the indemnity is how the risk is put back on the seller.

Buyers sometimes ask for wide indemnities covering anything at all that goes wrong, and sellers should resist them, as they turn every warranty into a guarantee with no disclosure against it. A narrow indemnity isn’t always the better route for a buyer either, as a warranty claim can sometimes recover more than the indemnity would. On a share sale there will also be a tax covenant, which is an indemnity for tax relating to the period before completion that wasn’t provided for in the accounts.

Limits on claims

The seller’s liability is normally limited in several ways. There’s a time limit for bringing claims (commonly around two years for general warranties and longer for tax), a minimum below which individual small claims are ignored, a threshold that the claims together must reach before any can be brought, and an overall cap, often linked to the price or to the part of it paid at completion. Where each one ends up depends on the deal and on how hard each side pushes.

The agreement will also set out how a claim has to be notified, and buyers lose valid claims by getting this wrong, either by missing the deadline or by not giving enough detail of the breach. None of the limits protects a seller who has been dishonest, as I’ve explained in warranty limits don’t survive fraud.

Retentions, escrow and insurance

A promise to pay is only as good as the person giving it, so buyers often want part of the price held back for a period after completion to meet any claims. That can be a retention, which the buyer keeps until the period ends, or an escrow account held by a third party, which sellers tend to prefer as the money isn’t in the buyer’s hands. The agreement needs to say when the money is released and what happens if a claim has been notified but hasn’t been resolved. Escrow arrangements are outside my standard scope and are quoted separately.

Warranty and indemnity insurance is also available, under which an insurer covers some warranty claims in place of the seller. It’s more common on larger deals, and whether it’s suitable is a question for an insurance broker, as I’m not able to advise on insurance.

Acting for a buyer or a seller

If you’re the buyer, you want wide warranties, specific disclosures only, indemnities for anything found in due diligence, long time limits and some of the price held back. If you’re the seller, you want the opposite, and in particular a sensible cap, a short time limit and a disclosure letter that has been properly prepared. Acting for both sides on different deals means I know what the other side’s solicitor will be pushing for and where these points usually settle.

Making or defending a warranty claim after completion is a dispute, and those go to my Nexa colleagues who deal with contract disputes.

How long it takes and what it costs

The warranties, disclosure letter and limits are negotiated alongside the rest of the sale agreement, during the two to three months a deal usually takes, and they’re part of my fixed fee for the transaction. Every quote is specific to the deal, but as a guide my fee will be between 0.5% and 5% of the deal value. Under £1m it’s usually 3% to 5% and over £1m it’s usually 1% to 2%, although it does depend on the business, the price and the commercial terms. The minimum fee is £3,500 plus VAT, and on lower value deals I can quote for a reduced, more standard service.

Next steps

If you’re buying or selling and want me to act, get in touch and send me the heads of terms and the draft agreement if there is one, and let me know whether you’re buying or selling.