Understanding the critical differences between warranties and indemnities in acquisition agreements, their scope, limitations, and what happens when they are breached.
Avv. Carlo Carta
M&A and Commercial Law Expert
Before acquiring a company, the buyer often conducts due diligence. Based on these investigations, the buyer will usually request the seller to include warranties and indemnities in the acquisition agreement. But what exactly are these terms, and what happens if either is breached?
Warranties are statements a seller makes according to which particular facts and circumstances are correct. Warranties are of a general, unspecific nature and may apply to different aspects of a company, from personnel to finance.
The seller issues a warranty that the balance sheet and profit and loss accounts for a certain period are correct and fairly represent the company's financial position.
Warranties are often restricted by disclosures. The seller includes a number of circumstances in the acquisition agreement to which the warranty does not apply.
Example of Disclosure:
"Warranties do not apply to findings a buyer could have been familiar with according to the due diligence report dated [DATE]."
An indemnity regards an identified, more specific risk where the seller indemnifies the buyer from damage the buyer might suffer in the event the risk becomes a reality.
A company is involved in legal proceedings. The result is still unknown, but the seller indemnifies the buyer from potential resulting loss, regardless of the outcome.
Indemnities are the mirror image of disclosures and therefore cannot be restricted by them.
While warranties can be qualified by disclosure schedules, indemnities provide absolute protection for specific, identified risks—the seller cannot later claim the buyer "should have known" about the issue.
If a warranty is breached, the buyer will claim the ensuing damage from the seller. The seller is not likely to admit defeat and shall rely on one of the disclosures.
"The buyer could have been aware of this circumstance on the basis of the results of the due diligence."
An acquisition agreement often contains:
Deadline for Validity
Typical survival periods: 18-24 months for general warranties, 6-7 years for tax warranties
Penalty Provisions
Caps (maximum liability), baskets (minimum threshold), and de minimis amounts
If nothing has been established with regard to breach of a warranty, the "normal" rules of the Dutch/Italian Civil Code will apply:
Fulfillment
Difficult to claim if warranty already breached
Termination
Usually excluded as reversal of acquisition is undesirable
Damages
Most common remedy—buyer must prove actual damage suffered
A seller will try to limit liability to the greatest possible extent by including the phrase "according to (the best) of the seller's knowledge" in the warranty conditions.
The seller does not issue warranties for circumstances he is not aware of. Unknown circumstances will be at the buyer's risk.
What "seller's knowledge" refers to is often included in the definitions section of the acquisition agreement. Common approaches include:
Actual Knowledge
Limited to facts actually known by specified individuals (e.g., CEO, CFO, legal counsel)
Constructive Knowledge
Includes facts that would have been discovered after reasonable inquiry or investigation
Risk Allocation Impact
A "seller's knowledge" qualifier shifts unknown risks to the buyer. As a result, further investigations could have been expected by the seller, or a certain group of people must have had actual knowledge before a warranty claim succeeds.
For Both Parties
Both seller and buyer are well-advised to distinguish between warranties and indemnities in an acquisition agreement. This clarity ensures everyone understands which claims can be made in the event of a breach.
For Buyers
Observe warranties with the wording "according to the (best) of the seller's knowledge". If necessary, include in the definitions that more detailed research by the seller will be expected.
For Sellers
Carefully prepare disclosure schedules and consider knowledge qualifiers to limit exposure. However, balance this with the buyer's need for adequate protection to ensure the deal closes.
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