Caveat emptor: How to avoid corporate disputes

In corporate deals, protecting your interests matters just as much as negotiating the price. When you are buying a company, business, or assets, the terms in the contract – particularly warranties and indemnities - become a crucial safeguard against unexpected risks. This article explores what these terms really mean, why they are so important in avoiding corporate disputes, and what happens when these terms are breached.

What are warranties and indemnities?

A buyer acquiring a company's share capital, business, or assets generally receives limited legal protection if the acquisition does not meet expectations, except in cases involving misrepresentation or fraud by the sellers. In such contracts, consideration should be given to warranties and indemnities. In corporate transactions, buyers commonly seek to include these provisions. These terms clarify each party’s responsibilities and outline how risks are managed. But what do these legal terms really mean, and how do they affect you?

A warranty is a factual statement provided by one party (the warrantor) to another (the warrantee) in a contract. For instance, when selling a business, the seller may warrant (confirm) that no legal disputes with employees are pending and that all tax filings are up to date. In Scotland and England & Wales, a warranty serves as confirmation that a particular condition or fact is accurate at the time of signing the contract.

A warranty in a contract is a condition essential to its validity, so breaching it is like breaching the contract. If a warranty proves false, the warrantee can claim for foreseeable damages to restore them to the expected position, considering what they knew at signing.

An indemnity, on the other hand, is a promise to cover specific losses if certain events occur. For example, a buyer might request an indemnity for potential liabilities from ongoing litigation against the target business/company.

Indemnities are read within the contract as a whole. Clear and unambiguous drafting is vital, as courts often favour interpretations less onerous for the indemnifier. An indemnity clause should define the payment amount, or the method by which it will be determined, and specify triggering events.

Though tax warranties and indemnities may overlap, they serve distinct purposes: warranties confirm facts to manage risk while indemnities provide recovery for specific losses.

As such, both clauses, while distinct in their functions, contribute to risk management strategy in corporate transactions. However, when these clauses are breached, the consequences can be significant.

Breach of warranty claims: how they arise and what can you do?

Breach of warranty claims arise when a party does not fulfil a contractual statement. Clear drafting of warranty clauses is essential as shown in British Overseas Bank Nominees Ltd v Stewart Milne Group Ltd. In this case, the Court found that the claim was ‘time-barred’ because the clause’s wording linked claim periods to those already expired. This emphasises the importance of precise language in warranty clauses to ensure enforceability.

Protections, remedies, and procedures for warranty or indemnity claims differ, making it essential to determine which applies to your contract. When pursuing a claim, you must demonstrate the following:

• Warranties: For breach of warranty, the warrantee must prove the warranty was false when given and show financial loss.
• Indemnities: An indemnity offers direct compensation for specified losses, without needing to prove a drop in value, covering particular risks affecting the warrantee.

What can you do if a breach occurs?

If a warranty is breached, there are certain steps you should take:

1. Review the contract: Examine the contract carefully for any limitation of liability clauses, notice provisions (including time limits) and available remedies.
2. Notify the breach: Promptly notify the other party of the breach within the timeframe specified in the contract.
3. Gather evidence: Collect all relevant financial records and correspondence to substantiate your claim.
4. Assess the loss: Clearly identify and quantify the losses incurred to facilitate an appropriate claim for damages.
5. Consider Legal Advice: Due to the complexity of these contractual terms, you should seek legal advice.

Warranties and indemnities play a pivotal role in corporate transactions, as they can provide a framework to manage risk and clarify responsibilities between parties. Clear and precise drafting of these clauses is crucial, as it can significantly impact their enforceability and effectiveness should anything go wrong, and avoid corporate disputes. In the event of a breach of warranty or indemnity, obtaining legal advice is recommended.

If you would like more information on warranties and indemnities, or anything else discussed in this blog, please get in touch with our corporate disputes lawyers, or your usual Brodies contact.