One of the advantages of purchasing an established business is that you get to hit the ground running, with much of the structure, systems and legalities already in place. Hooray!
Despite these benefits, it is important that you are also aware of the risks involved. One of the most powerful ways you as a Purchaser can protect yourself against these risks is by negotiating broad and robust Vendor Warranties.
Why are Vendor Warranties Important?
Vendor Warranties are important as they form the basis of the Purchaser’s entry into the contract. Where a warranty turns out to be incorrect or false, a Purchaser will generally have a right to reclaim losses incurred (or at least some of it) from the Vendor. As a consequence, Vendor Warranties are often the most fiercely negotiated aspect of the sale contract.
It is paramount that consideration of each Vendor Warranty is not just an afterthought, but instead negotiated and carefully examined as they apply to the specific business being sold.
Key Vendor Warranties
Some of the key Vendor Warranties that we regularly consider are:
- Ownership – the promise that the Vendor is the true owner of the assets it intends to sell.
- No Encumbrance – the promise that the assets are not subject to security interests or other matters that would prevent you from receiving proper title to the asset.
- Accounts – the promise that the accounts give the Purchaser a true and fair view of the business and have been prepared according to generally accepted accounting standards.
- Contracts – the promise that the Vendor operating the business is not in breach of (and potentially liable for damages) under any of its contracts.
- Property – the Vendor operating the business is not in breach of its lease (if applicable) and has not received any critical notices (such as a notice to vacate).
- Environment – the Vendor operating the business is not in breach of environmental laws (such as contamination).
- Intellectual Property – the Vendor operating the business owns or has the right to use all the relevant Intellectual Property.
- Litigation – there are no current or threatened claims against the business.
- Employees – the employee entitlement list is accurate and all payments required to be made have been made.
- Solvency – the promise that the Vendor is solvent.
- Insurance – the promise that all insurance policies are current.
- Taxes – the Vendor operating the business has lodged the necessary tax returns and no tax audit is pending or threatened.
But wait, there’s more! You may also need to be aware of any ‘liability caps’ or ‘warranty time limits’ included as part of any of the Vendor Warranties. Whilst the documentation may include broad warranties, if limits or caps also appear, this may increase your exposure to risk.
If a liability cap is present, the amount a Purchaser will be able to recover from the Vendor may be reduced if one of the key warranties turns out to be untrue, thereby affecting the value of the business.
Equally, a warranty time limitation for claims against the Vendor can significantly impact a Purchaser’s ability to make a warranty claim against the Vendor. If a purchaser only becomes aware of the falsity of a specific promise outside the limitation period, the warranty may not be of much use.