Warranties and indemnities

What it means

Warranties and indemnities are the seller's statements about the condition of the company being sold and its commitment to compensate the buyer if they prove untrue. They cover, for example, taxes, litigation, contracts, employees, assets, the financial statements and regulatory compliance.

Warranties are statements of fact at a given date, for instance that the company has no tax arrears. An indemnity is a commitment to compensate a specific known or potential loss regardless of any breach of warranty, for example for a particular pending dispute.

Warranties and indemnities are a key part of a share purchase agreement and of an agreement for the sale of a business. They allocate between the parties the risk of unknown problems that due diligence did not uncover or could not verify.

How it works in practice

Due diligence findings shape the warranties the buyer asks for. Known risks are usually dealt with through a specific indemnity or a price reduction, while unknown risks are covered by general warranties. The seller can limit warranties by disclosing facts about the company.

The seller's liability is usually capped in amount, for example as a percentage of the price, limited in time for bringing claims, and subject to a minimum claim threshold. These limits resemble a liability cap in ordinary contracts.

In larger deals, warranty and indemnity insurance is increasingly used, covering the buyer for breaches of warranty instead of the seller. It makes it easier for the seller to exit without a long holdback of part of the price and gives the buyer certainty of recovery.

What to watch out for

Warranties must be drafted precisely. Vague or overly broad statements lead to disputes over whether they were breached. The buyer should insist on warranties covering key risks, while the seller should disclose known facts carefully to limit its liability.

A warranty claim must be made within the agreed period and in the prescribed form. If the buyer discovers a problem after closing, it should act quickly, gather evidence and notify the seller in writing, otherwise it may lose the claim even though the warranty was breached.