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Breach of warranty in an SPA...

Updated: Apr 5

How a buyer can rectify a broken promise, and words of caution for the seller

Preparing for an M&A deal is busy and exciting. There’s the business expansion, wealth creation, and selling a lifetime’s work to retire in the sunset. But both the buyer and the seller should have a firm handle on the less glamorous aspects of the transaction; namely the legal implications of the formal agreements.

As dispute resolution solicitors, we’re often involved in picking up the pieces of deals that have cracked, or crumbled after completion. And it usually comes down to an oversight or misunderstanding of the warranties included in the share purchase agreement (SPA).

So what do you need to look out for in your warranties to minimise the risk of litigation after the sale?

The function of warranties in an SPA

The warranties are given by the seller to inform the buyer of the state of the business. In the same sentiment as buying a house (but on a more complicated scale), the buyer wants a clear picture of the business they are acquiring in order to determine a price that reflects its true value.

The specific warranties included in the SPA will depend on the business and the industry, but they will usually cover: the financial position of the business, the accounts, the commercial contracts, property, tax, compliance.

All sale and purchase transactions under UK law work on the basis of “caveat emptor”. Literally that translates as “may the buyer beware”. Practically, it means that it’s the buyer’s responsibility to find out all the defects. The warranties then are the legal protection for the buyer, and the contractual tool by which the buyer can rectify defects discovered after the purchase.

Remedies for breach of warranty in an SPA

So what can you do if you suspect that the seller gave inaccurate information in the warranties?

You can look at bringing a contractual claim for breach of warranty.

The nature of the claim means that you can’t terminate the contract and get all your money back. That’s an important issue to note. You’re not entitle to reverse the deal for a breach of one of the warranties.

But you can sue for damages. The measure of those damages will be the difference between the price you paid for the business, and what the business would be worth, had the warranty been correct.

In some limited circumstances, you may be able to bring a claim for misrepresentation, a topic for another time!

Buyers: Where to begin in a breach of warranty claim

The most important advice for buyers in a breach of warranty claim is to act quickly.

In most SPAs there will be notification provisions for a breach of warranty claim. If you fail to notify the seller of your intention to bring a claim within that time limit, then you are likely to be barred from bringing a claim at all.

You should also estimate your losses at an early stage. Of course, these claims can be complicated and often you will need expert evidence to determine the loss accurately. But the SPA will probably include financial limits on the losses. You need to have a rough idea of whether your claim falls within the financial liability cap to make sure it’s a claim worth pursuing.

Sellers: How to protect yourself from a claim

For sellers, the advice is to be transparent and meticulous during negotiations.

You have the opportunity to give disclosures to the buyer, and these are your most effective shield against a breach of warranty claim. The buyer can’t complain about an issue you told them about in your disclosure letter, so make your disclosures as full and transparent as possible.

When you’re presented with draft after draft of the SPA, it’s easy to lose your fervour in reviewing it. But it’s vital that you are meticulous every time your read through it. When it comes to the warranties (or any other provision), you mustn’t allow yourself to think “that’s probably correct” or “that sounds about right”. Make sure you investigate all of the warranties you’re giving, so that you can stand behind them with confidence.

Getting lawyers on board

When you suspect that your new acquisition isn’t exactly what it seemed, who do you instruct to take your case? Or, if you’re on the other side and you were the seller who has received a claim notification from the buyer, where do you turn?

Your first thought is likely call upon the lawyers who drafted the SPA for you. That makes sense because they have the background to the deal and they know you and your business.

But, these claims can bring up issues of professional negligence, in which case your previous lawyers would be conflicted from acting for you any further. In any event, new lawyers can give you a second professional opinion on the warranties they would have included in the SPA and how they would articulate them.

So there are a few reasons to think carefully about which lawyers you instruct and you may decide to get different lawyers on board for bringing or defending your claim.

If you want experienced solicitors, committed to your case, please give us a call at HooperHyde.

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