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Warranties and indemnities in an acquisition agreement

Publication date: 7 June 2018
Regarding the results of this investigation, the seller will usually issue warranties and indemnities in an acquisition agreement. Warranties are provisions a seller issues according to which he ensures that certain general facts and circumstances are true. A breach of these warranties can result in a damage claim. An indemnity relates to a specific risk where the seller will be liable for potential buyer’s damage. In the event of a breach of indemnity, fulfilment can be claimed. Warranties with the wording “according to (the best) of the seller’s knowledge” will ensure risk shifting to the buyer.

onderhandelen contract

Before the acquisition of a company, the buyer often conducts due diligence. Based on these investigations, the buyer will usually request the seller to include warranties and indemnities in the acquisition agreement. What are warranties and indemnities? And what happens if any of these is breached?

Warranty

Warranties are statements a seller makes according to which particular facts and circumstances are correct. Warranties are of a general, unspecific nature and may apply to different aspects of a company, from personnel to finance. An example of a warranty would be a balance sheet warranty. Here, the seller issues a warranty that the balance and the profit and loss accounts of a certain period are correct.

Warranties are often restricted by disclosures. The seller includes a number of circumstances in the acquisition agreement to which the warranty does not apply. An example for a disclosure would be that warranties do not apply to findings a buyer could have been familiar with according to the due diligence.

Indemnity

An indemnity regards an identified, more specific risk where the seller indemnifies the buyer from damage the buyer might suffer in the event the risk becomes a reality. Thus, indemnities can for instance be issued if a company is involved in legal proceedings. The result of the proceedings is still unknown, but the seller indemnifies the buyer from potential resulting loss.

Indemnities are in fact the mirror image of disclosures and therefore cannot be restricted by them.

Breach

If a warranty is breached, the buyer will claim the ensuing damage from the seller. The seller is not likely to admit defeat and shall rely on one of the disclosures. For instance, the buyer could have been aware of a circumstance on the basis of the results of the due diligence.

An acquisition agreement often contains a deadline for the validity of a warranty, and, additionally, a penalty provision for the breach of a warranty will be included.

If nothing has been established with regard to breach of a warranty, the “normal” rules of the Dutch Civil Code will apply. Thus, for instance, fulfilment, termination, and/or damages can be claimed. Termination is usually excluded in acquisition agreements, as reversal of the acquisition is undesirable. It is often difficult to claim fulfilment of a warranty as it has been breached. Therefore, often a claim for damages will be opted for. For this, the buyer must have suffered damage however.

Things are easier when it comes to breach of an indemnity. In this situation the buyer can just claim fulfilment of the indemnity. After all, it was agreed upon in advance that the seller is liable for any damage with regard to the circumstances of the indemnity.

“According to (the best) of the seller’s knowledge”

A seller will try to limit his liability to the greatest possible extent in an acquisition agreement by including the phrase “according to (the best) of the seller’s knowledge” in the warranty conditions. This means, the seller does not issue warranties for circumstances he is not aware of. Unknown circumstances will be at the buyer’s risk. What “seller’s knowledge” refers to is often included in the definitions of the acquisition agreement. As a result, further investigations could have been expected by the seller or that a certain group of people had actual knowledge.

Our advice

Both seller and buyer are well-advised to distinguish between warranties and indemnities in an acquisition agreement. This way it will be clear what the disclosures apply to and which claims can be made in the event of a breach. As a buyer, make sure to observe a warranty with the wording “according to the (best) of the seller’s knowledge”. If necessary, include in the definitions of the acquisition agreement that more detailed research by the seller will be expected.

More information?

Would you like to learn more about warranties and indemnities? Or do you have any other questions regarding a takeover? Please contact Russell Advocaten:

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