When entering a business transaction, whether as a Buyer or a Seller, the issue of warranties often provides for extensive negotiations to the transaction. Generally, a Seller wants to provide as few warranties as possible, whereas the Buyer wants ample warranties to be provided by the Seller regarding the nature and operation of the target company group.
A breach of warranty presents a risk to the breaching party – they may be sued for damages, which can be quite significant depending on the breach. A thorough understanding of the function of warranties, their impacts in business transactions, and the consequences for a breach can help to manage these risks.
What is a warranty?
A warranty is a statement of fact made by one party to the other. Quite often, it will be a statement by the Seller about the affairs of the target entity that is being purchased by the Buyer. They tend to be given at a point of time in the transaction. Phrases like “as at the Completion Date” or “at the time of signing” are commonly found in warranty provisions as they provide a point of time for when the warranty is given by the Seller.
Warranties are used as a way to allocate risk between the parties. If a party provides a warranty as to the state or nature of the business and this turns out to be untrue, then the affected party will have the right to remedies from the breach of warranty, provided that the affected party has suffered damaged.
There are many different types of warranties that are provided for in a transaction. They are largely influenced by the type of business or industry the target company operates in. Some common warranties that appear in acquisitions are:
- Employment warranties;
- Legal Dispute warranties;
- Warranties that relate to the operation of the business;
- Accounts warranties;
- Plant and Equipment warranties; and
- Intellectual Property Rights warranties.
However, the list of warranties provided by a party can be far more exhaustive depending on the nature and size of the transaction.
Breach of warranty
A warranty is breached if a party provides the statement of fact, and it is later determined not to be true. The time provisions included in agreements determine the point at which the breach actually occurs; these will either be at the date of signing, the completion date, or both. It is important that these time provisions are appropriately considered depending on the type of warranties being provided.
The discovery of a breach of warranty may not occur until after the completion of a transaction. If a breach of warranty is discovered, the Buyer must have suffered loss as a result of the breach. As the general remedy for a breach of warranty is damages, if a party has not suffered any actual loss, there can be no remedy for damages.
It is also important to note that there are time limits around a breach of warranty and when a party can bring an action for breach of warranty. Generally, these time frames begin from the time the breach occurs, and not from when the breach is discovered. It is quite common for parties to place limitations on the period of when the other party may bring about a claim for a breach of warranty.
What remedies are available for breach of warranty?
It is important that the consequences and remedies that flow from the breach of a warranty are clearly articulated in the agreement. Generally, the nature of a warranty is not considered to be an essential term. Therefore, a breach of warranty does not give rise to termination rights for the party that has suffered damage as a result of the breach. The remedy applied to a breach of warranty is usually a right to damages.
A party may have termination provisions for breach of warranty drafted into a contract. This is best achieved by having the termination provision in the contract clearly identify which breach, of which warranties, will allow the affected party to terminate and recover damages. This will quite often be negotiated between the parties, as the right to terminate due to breach of warranty would likely benefit one party significantly more than the other.
What does this mean for you?
The importance of warranties cannot be underestimated – they provide necessary protections, but can also raise potential risks. Warranties perform an important part of contractual negotiations in the sale or acquisition of a business or company to ensure all parties are satisfied. Seeking legal advice from an experienced Commercial Lawyer in any transaction will help ensure your interests are covered.
