Why are carefully drafted warranties advisable in share purchase agreements?

When acquiring or selling a company, a Share Purchase Agreement (SPA) can be an effective way to allocate risk between the parties during the deal and after it is closed.

Warranties are a crucial part of an SPA. They provide reassurance about the true state of the business for buyers and define ongoing liabilities for sellers.

Having clearly drafted warranties is essential to protecting your position in any share transaction.

Our Company Law Associate Solicitor, Jonathan Hol, explains how warranties work in SPA agreements and what they should include.

What are warranties in a Share Purchase Agreement (SPA)?

Warranties are contractual statements usually given by the seller about the condition of the company at the point of sale.

If a warranty later proves to be untrue and the buyer suffers loss as a result, the buyer may bring a claim for breach of warranty.

Warranties often cover a range of matters, including:

• Title and ownership – confirmation that the seller owns the shares and has the legal right to sell them.
• Capacity and authority – assurance that the seller can lawfully enter into the transaction.
• Accounts and financial information – confirmation that the company’s accounts are accurate and reflect its financial position.
• Legal compliance – confirmation that the business complies with relevant legislation and regulatory requirements.
• Contracts and obligations – disclosure of material contracts and confirmation that there are no undisclosed liabilities.

There are two categories of warranties, which are fundamental and general warranties.

Fundamental warranties, such as title to shares and authority to sell, are core protections and are often subject to fewer limitations.

The general warranties focus on aspects including the company’s trading, assets, employees, property, intellectual property and financial standing.

Why are warranties so important in SPAs?

Warranties can provide reassurance for a buyer that the business, they are acquiring, is as described during negotiations and due diligence.

They also provide a remedy if something material has been misrepresented.

For example, if the seller warrants that there is no litigation, but the company is facing a significant undisclosed claim, the buyer may be able to recover losses arising from that issue.

Warranties can also define the extent of the seller’s ongoing liability.

Most SPAs can include limitations on warranty claims, including:

• A financial cap, often linked to the purchase price
• A de minimis threshold for small individual claims
• A basket threshold before aggregate claims can be pursued
• Time limits for bringing claims, often one to three years
• The buyer is first to have recourse from insurance (if loss is covered) or seek to recover the loss from a third party before approaching the seller

Why is clear drafting of warranties needed?

Warranties are heavily negotiated and must be carefully drafted, as ambiguous or overly broad wording can lead to disputes and unintended liability.

Clearly drafting warranties can ensure that:

• Risk is fairly allocated between the parties
• Liability caps and time limits are enforceable
• The agreement reflects the findings of due diligence
• Dispute resolution is clearly set out

How can legal support protect your SPA?

Our professional team can help negotiate and draft warranties in your SPA and advise you on the appropriate caps, thresholds and time limits.

Having the right legal support when drafting an agreement can help protect your interests during the deal and after it is completed.

If you need further advice on share acquisition agreements, contact our Company Law team.