Guarding against post-deal surprises: the crucial role of warranties and indemnities

Guarding against post-deal surprises: the crucial role of warranties and indemnities

Lydia Sevenoaks, Corporate

When you’re buying a company or business, negotiating warranties and indemnities is one of the most important, and often most time-consuming, parts of the deal.

These provisions sit at the heart of most sale and purchase agreements. Understanding how they work can make a real difference to the level of risk you take on.

What are warranties?

In simple terms, warranties are promises made by the seller about the condition of the business.

They typically cover areas such as:

• financial statements
• key contracts
• employees
• litigation
• assets
• tax
• legal and regulatory compliance

Warranties serve two main purposes.

1. Protection for the buyer
If a warranty turns out to be untrue and the buyer suffers loss as a result, the buyer may be able to bring a claim. In this way, warranties act as a form of price adjustment after completion.

2. Encouraging disclosure
Warranties also force the seller to carefully consider the state of the business. Through the disclosure process, the seller must flag anything that would make a warranty inaccurate. This often brings issues to light early, giving the buyer the chance to assess them properly.

Warranties are given at a specific point in time—usually completion—and are typically set out in a separate schedule to the purchase agreement.

They must always be read alongside the disclosure letter. This is a key document in which the seller lists any known issues that would otherwise breach the warranties. Anything properly disclosed will qualify the warranties, meaning the buyer cannot later claim for that issue.

Negotiating warranties and disclosures is often one of the most intensive parts of the deal. It’s a live process that continues right up to completion and requires careful management on both sides.

Financial thresholds: de minimis and baskets

Most agreements also include financial thresholds that limit when a buyer can bring a claim.

These usually work in two layers:

• De minimis: each individual claim must exceed a minimum amount (for example, £1,000) before it can be pursued.
• Basket/threshold: the total value of claims must exceed a higher figure (for example, £10,000) before the seller becomes liable.

Only once that threshold is met can the buyer recover losses. This prevents minor issues from turning into disputes while still protecting the buyer against more significant problems.

What are indemnities?

Indemnities are different.

They are specific promises by the seller to reimburse the buyer if a particular liability arises. They are usually used where due diligence has identified a known risk that:

• hasn’t yet materialised
• can’t be precisely quantified

Indemnities are tailored to each deal. Common examples include:

• employee or employment risks
• property issues
• ownership of key assets (such as domain names)
• health and safety concerns

It’s also standard to include a tax covenant, which is effectively a form of indemnity covering pre-completion tax liabilities.

Indemnities generally offer stronger protection than warranties. The buyer doesn’t need to prove loss in the same way, and the recovery is often more straightforward. Because of this, they are heavily negotiated.

Limiting liability

Sellers will almost always look to limit their exposure. Common limitations include:

• Several liability: each seller is only responsible for their share of the proceeds
• Time limits: claims must be brought within a defined period
• Financial caps: liability is capped, often at the purchase price (or a percentage of it)

Buyers, on the other hand, may push for joint and several liability, allowing them to recover the full amount from any one seller.

This can be contentious, particularly where sellers are not closely connected. In those cases, a deed of contribution is often agreed between the sellers to set out how they will share liability between themselves.

What you need to know

One of the biggest challenges for any buyer is understanding the risks they are taking on.

No matter how well a business presents itself, there will always be:

• gaps in information
• historic liabilities
• future uncertainties

Warranties and indemnities form the contractual framework that protects against those risks.

• Warranties: provide reassurance about the state of the business
• Indemnities: provide targeted protection for known issues

Used properly, they help ensure the buyer gets what they think they’re buying—and that the price reflects the true risk profile of the deal.

That said, they are only as effective as the due diligence behind them.

They should never be a substitute for due diligence, they should be the result of it. When aligned with a thorough investigation of the business, they allocate risk clearly, address known issues, and provide meaningful protection.

When due diligence is rushed or incomplete, that alignment breaks down and the risk of post-deal surprises increases.

Considering buying or selling, or want to better understand the due diligence process? Get in touch with Lydia Sevenoaks.