Some of the most important clauses in a sale of business agreement or a sale of shares agreement, are the clauses recording the warranties and indemnities that the seller gives to the purchaser about the business, the company that owns the business, or the shares that are being sold.
Unless the purchaser knows the company and its business very well (for example, where the purchaser has been an executive director of the company for many years) or the purchaser is only buying a minority percentage of the issued shares in the company, it is common that the purchaser will want numerous and detailed warranties and indemnities from the seller.
Warranties commonly relate to:
- the authorised and issued shares in the company;
- the legal status, financial accounts and statements, and tax compliance of the company;
- the operations of the company, for example:
- what litigation is threatened or pending (with customers, suppliers or employees);
- whether the company is in default of any payment obligations;
- whether the company is in any material dispute with any governmental bodies;
- that the company has all licenses and permits its needs for the lawful conduct of its business;
- what insurance the company has in place;
- various aspects in respect of the company’s employees, including recording how many there are, their gross salaries and their outstanding benefits, and that there are no complaints against the company under labour laws from any employee or ex-employee;
- that the company’s assets are not subject to any mortgage or other kind of bond, cession in security, or the like;
- recording certain rules for how the company and business will be run during the interim period between the signature date of the sale agreement and the date it is finally effected.
The warranties can also include matters that are specific to the company or its business, such as warranties relating to:
- any movable property that the company owns;
- any immovable property that the company owns;
- any intellectual property that the company owns;
- key customer or supplier contracts or licenses.
It is extremely important for the seller to be certain that each of the warranties are accurate, and if they are not, to disclose in the agreement the extent to which they are not accurate. This is done in a disclosure schedule which is attached to the agreement. Concluding the disclosure schedule carefully will ensure that the seller cannot be held liable for a breach of a warranty if it falls within something that has been disclosed.
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The following points relating to the warranties and indemnities clauses are often strongly negotiated between the parties to these sale agreement:
- for how many years after the sale has become effective are the warranties effective? For example, is it 3 years or 5 years, or perhaps different time periods for different categories of warranties?
- if there is a breach of the warranties:
- is there a minimum rand amount that the purchaser’s claim must be for, in order for the seller to be liable for it?
- is there a maximum rand amount that the purchaser can hold the seller liable for (for example, a maximum amount equal to 50 % of the total purchase price)?
- can the purchaser withhold any amounts from payments it still needs to make to
the seller under the agreement (for example if the purchase price was being paid in tranches), until the breach has been remedied or the indemnity amount has been paid to the purchaser?
- does the fact that the purchaser conducted a due diligence on the company and its business detract from or limit any of the warranties or indemnities that the seller gave?
- if there is a breach of a warranty, can the purchaser cancel the agreement entirely, or does the purchaser only have a monetary claim for damages?
Written by Abigail Reynolds (Corporate & Commercial Law Specialist)
This article originally published by Reynolds Attorneys