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M&A Warranties, Representations & Indemnities

The three key components of Warranties, Representations & Indemnities are an important part of a Sales & Purchase Agreement (SPA). The context is different to a normal understanding of the terms so understanding is vital to avoid ambiguity.

Discover the legal interpretation of these three key components of an SPA and how each method commits the seller contractually. This is the second episode in our second video series, “M&A Deconstructed”, here we deep dive into what are Warranties, Representations & Indemnities.

We scope setting limitations and thresholds in the process, enforcement in case of a breach in each treatment and the increasing popularity of warranty and indemnity insurance (W&I insurance) in a company sale.

Watch the video below for the in-depth discussion.

Quick Find Timeline:

00:00 – Introducing warranties, representations & indemnities in M&A
01:33 – What are the differences between Warranties, Representations & Indemnities?
02:26 – What are warranties in M&A?
04:00 – What is the difference between warranties and indemnities?
05:56 – What are indemnities in mergers and acquisitions?
06:55 – What are representations in mergers and acquisitions?
08:37 – Claims, mediation and court action in mergers ad acquisitions
11:57 – How are warranties, representations and indemnities linked to due diligence?
13:18 – Who drafts Warranties, Representations & Indemnities?
14:29 – Warranty and indemnity (W&I) insurance

Series 2 – Topics

The conversations in the second more technical series of videos include:

  1. What is a Sales & Purchase Agreement (SPA)?
  2. M&A Warranties, Representations & Indemnities
  3. Getting Paid: Earn-Outs, Deferred Payments & Vendor Loans
  4. What could Derail a Company Sale? Learn how to avoid the main pitfalls
  5. How much does it Cost to Sell a Company?
  6. 5 Insider Tips: A Successful Company Sale

In case you missed our first series you can watch the videos on catch up below:

  1. Introduction to the M&A Deconstructed series of videos
  2. What is EBITDA?
  3. What are Heads of Terms?
  4. Equity Share vs Asset Sale
  5. Completion Accounts vs Locked Box
  6. What is Due Diligence (DD)?

Meet your M&A experts

Nick Davies, Partner | M&A Solicitor, Steele Raymond LLP Solicitors
Nick acts for a wide range of business clients across various sectors, advising on complex corporate transactions including company sales, purchases and mergers. Nick also advises on on mergers, de-mergers and re-organisation.


Steele Raymond LLP
Richmond Point, 43 Richmond Hill, Bournemouth, BH2 6LR

TheNonExec Limited
Contact us here to chat about your business exit.

Transcript for M&A Deconstructed

Transcript for video: Warranties, Representations & Indemnities

Nick Davies (00:07):
Morning, Justin. Welcome back.

Justin Levine (00:08):
Morning, Nick.

Nick Davies (00:09):
How are you?

Justin Levine (00:09):
Yes, good. Good today. Thank you. Yes.

Introducing Warranties, Representations & Indemnities

Nick Davies (00:10):
Excellent. So we’re here again today to do another of our videos, demystifying some of the M&A terminology and process. We recently did a video, which was hopefully helpful for people, on what is an SPA, Share sale and purchase agreement. We talked about a key component of that document being the warranties, and we know that warranties can also include representations, indemnities. So we’re going to talk a little bit today about those. Try and provide a bit of insight for people. So from your perspective, what is the main area of confusion for clients on warranties, indemnities representations? What questions do you get asked and what do you think people struggle with?

Main Areas of Confusion

Justin Levine (00:56):
It’s a good question. I mean, the answer is actually all of it. Because most, if not all my clients, when it comes to the SPA, (sale and purchase agreement), and it comes to the part that’s embodied in that, enclosed in that. The notion, the term of warranties, indemnities, representations. Clients are familiar with the term warranty, but it’s often in terms of their own business. They might make a product that they offer a warranty on so, of course, the term is familiar but not in the context of selling a business.

Nick Davies (01:32):
Not in the legal meaning of the word.

Legal Interpretation of Warranties, Representations & Indemnities

Justin Levine (01:33):
Not in the legal meaning and I think, if I was being quite candid, I’d say even after selling the company and going through the process, there’s also a degree of ambiguity as to exactly what they are. I know the legal counsel will take a client through this and explain it in minute detail as you go through the process, but I think it’s quite complicated. So, I think probably what would be helpful is let’s just break each one and down: A seller is asked to make representations. They are asked to give warranties, and they are asked to give indemnities. What are the key differences between them? What are they?”

Main Objectives

Nick Davies (02:07):
Yes, sure. Okay. I appreciate it can be complicated, because there are so many different headings and different…. All these are all designed to achieve a similar purpose, and that’s to give comfort to a buyer about certain factors within the business.

Explanation of Warranties in M&A with Examples

Nick Davies (02:26):
Warranties are probably the most extensive section of the SPA. You’ll have a warranty schedule in the SPA, and that will include dozens, probably hundreds in some cases, of statements of fact about the company that’s being sold. And the sort of things that it will cover are shares, contracts, insurance, employees. And if I just give you an example of a warranty, it may be that no employee is currently suing the company for unfair dismissal or for some other breach of the employment legislation.

Responsibility of the Seller for Warranties in a Company Sale

Nick Davies (03:07):
And as a seller, you would be reading that warranty and thinking, “Yes, that’s correct. We’re not currently being sued.” So, you don’t have a problem. You’re making that commitment to the buyer to reassure them about that particular situation in the business, and everything’s rosy. Or you may read that warranty and think, “Oh, actually, we are being sued. There’s an issue with an employee.” So, you should then be going to the buyer and saying, “We need to disclose against that warranty to tell you about a situation we’ve got in the business.”

Sellers Commits Contractually to the Buyer Statements of Fact about the Business

Nick Davies (03:36):
And the warranties are often described as a sort of information-flushing exercise. Really that’s the role of due diligence, and really issues such as I’ve just described about employees and so on should be coming out in due diligence. But the warranties are a way of getting the sellers to commit to the buyer contractually these statements of fact about the business.

The Distinction with Indemnities and Setting Limitations

Nick Davies (04:00):
The distinction with indemnities, and there should be less indemnities typically in an SPA, is that warranties are subject typically to a number of limitations. And what I mean by that is that you don’t want to sign a share sale and purchase agreement and have these warranties open and sort of hanging over you ad infinitum. I think, as any sensible seller would want to know, “Well, 12, 18, 24 months after I’ve sold the company, the buyer cannot have a cause of action against me, if these warranties turn out to be untrue, inaccurate, misleading.”

Types of Limitations – Time, De Minimis

Nick Davies (04:40):
So, those warranties we’ve talked about, there being this large schedule in the SPA, they’re subject to limitations. And the sort of limitations will be time. There might be some de minimis thresholds, and by that we mean that a buyer would have to have a claim which exceeds a certain threshold value. Let’s say, for example, there’s a warranty about assets in the company, and it turns out that that warranty is incorrect by £10, and the real position is there’s £10 less of asset value in the company than was warranted. Now, a seller would say, “Well, come on. That’s de minimis. We don’t expect you to have the right to bring a claim for us for that.” So you’d have a de minimis threshold, which would normally say, “A claim has to exceed a certain value before a buyer can bring it.”

Multiple de Minimis Limitations Aggregate to a Basket Threshold

Nick Davies (05:27):
As well as the de minimis limitation, we also have what we call a basket limitation, and that might include a multiple of claims. So you have to get above then a higher threshold. So if your de minimis threshold was say, £5,000, your basket level might be £25,000. So, you’d have to have qualifying claims, which each of which would have to be over the de minimis but then in aggregate, they’d have to exceed the basket threshold.

Limitations on Indemnities

Nick Davies (05:56):
Indemnities don’t tend to have those limitations. Indemnities are for particular and specific areas of risk, which have been identified in due diligence. They might relate to an ongoing piece of litigation. They might relate to an ongoing tax issue. They might relate to some failure to deal with the share capital in some way. And what a buyer is really saying there is, “We have identified this issue as a particular area of risk for us as a buyer, and what we wish to do is allocate that risk onto the seller via an indemnity.” Sellers would not have the benefit of the full suite of limitations against those indemnities, but you can often negotiate some limitations. You might say, “There’s a cap on the indemnity.” You might say, “There’s a time threshold.” So that’s indemnities, that’s warranties.

What are Representations?

Nick Davies (06:55):
Representations are slightly different again, and I think this is where it perhaps becomes unhelpful or unclear. Warranties can be described as being given simply as warranties, and that means that they are contractual statements which can be enforced by the buyer. That means that the buyer has the usual remedies for breach of contract. If the warranties are described as also being given as warranties and representations, the buyer may have an additional claim for misrepresentation.

Potential Remedies for Misrepresentation Including Rescission

Nick Davies (07:30):
Misrepresentation widens up some further potential remedies, and in some extreme cases can include rescission. That is undoing the contract, going back to where the parties were before it was signed. That’s fairly extreme and in my view, it’s less common to see warranties given as representations as well. In some cases it’s justified. In some cases it’s necessary, but this is a point of negotiation between the buyer and the seller. So that’s a sort of summary of the distinctions. I hope that helps.

Summary of Warranties and Risk

Nick Davies (08:03):
I mean, it is slightly technical, slightly complex. I think that if people sit down, take the time to think about it, and we describe it, people can get a grip on it. It’s very important to understand. You want to be very clear when you are signing up on your share sale and purchase agreement, what statements are you giving? How long are you giving them for? What’s your maximum exposure? In what period do the warranties expire essentially? What are the thresholds we’ve talked about? You want to be absolutely clear on that, so that when you are looking at your own business, you can think, “Well, what’s the risk for me in signing these warranties?” That’s the key point.

Justin Levine (08:38):
I think it’s interesting because owners of SMEs, small and medium sized companies, in my experience are very surprised, if you like, that a buyer is going to acquire their business and then ask the seller to commit to warranties and indemnities, and that’s a repeated thing I come across. People expect, “Hang on a second. You buy my business, you take it. That’s that.” And of course it isn’t, but I think that there is a material element to it. And if I just distill it down is… And this is my non-expert view, and I hope you correct me as we go through.

Nick Davies (09:10):

Breaches of Warranties vs Indemnities

Justin Levine (09:11):
But with warranties, if the seller agrees to warranties, if the buyer suspects there has been a breach, then the buyer has to take legal action, go to court and effectively prove that there’s been a breach of warranty and then make a claim. Whereas with an indemnity, that’s different, isn’t it? With an indemnity is in effect, if there has been a breach, the buyer can claim on a pound for pound basis without having to go through that hoop. Have I understood that correctly?

Warranty Claim and Court Actions

Nick Davies (09:38):
Yes, that’s largely correct. I mean, the only point I’d make is on a warranty claim, you don’t necessarily have to end up in court. I think that court actions are becoming rarer and rarer these days, just because of the way the court system is and the costs. So, if a buyer wishes to instigate a warranty claim, what will first happen is the buyer will investigate the alleged or purported claim. They will make their case, and they will set it out in a letter of claim to the sellers. The sellers will look at that and they will either think, “Oh, yes. We’re on the hook for that. That’s a shame. Let’s negotiate a settlement and pay whatever the claim may be.” Or the sellers may look at that claim and think, “This is nonsense. We don’t agree, and we wish to challenge it.” So you’ll write back and say, “We don’t agree.” Set out your position, and there will then commence this sort of negotiation and everything else.

Mediation and Court Action

Nick Davies (10:26):
If the parties fundamentally cannot agree over time, then a mediation may happen or a court action may happen, as you say. But in each and every case, the warranty claim will be subject to those limitations I’ve described. So, they have to get the claim in in the right time period, they’ll have to exceed the value thresholds, they’ll have to serve the claim in accordance with the process set out in the SPA. That means sending it correctly. First class post, courier, whatever it might be, to the right address. That’s just got to be done right. So that’s how a warranty claim would typically work.

Nick Davies (10:59):
On an indemnity, you’re right, in that the reference to pound for pound really suggests or makes clear that you are not subject to these thresholds, and if you suffered a £1,147 loss, under your indemnity you’re entitled to recover that £1,147 loss. You’re not subject to those limitations. Even on receiving an indemnity claim from a buyer, a seller may still say, “I don’t agree.” I think that it’s easier to enforce an indemnity, because it should have been drafted and crafted in such a way that makes it very clear where the risk is of allocated between the parties. And I think that a reasonable seller, if they’ve agreed to give an indemnity, they understand very clearly that they’re on the hook for that issue should it arise. So, that’s the slight difference in process in enforcement terms. Yes, your summary distilled it well.

Issues tend to get Uncovered at Due Diligence

Justin Levine (11:57):
Okay. Thank you for that. The key thing from my side is that there is a link between the due diligence, the sale and purchase agreement, the SPA and the reps, warranties and indemnities. And the point being, from my side, is looking upstream, a lot of the issues that come out in the due diligence, or can come out. Intellectual property, IP, issues, tax issues, environmental issues, health and safety, labor contracts and so on. A lot of them are very preventable way upstream.

Nick Davies (12:24):

Prevent Issues Prior to a Sale

Justin Levine (12:25):
And that’s the key point. Is that actually, as much as it’s like selling anything but particularly a company, the more the preparation work is done upstream to identify those pre-sale, do the pre-due diligence, fix the issues, the less likely it flows downstream, where the seller has to sell a business and be on the hook for potentially serious things. But the question is, Nick, who drafts these?

Nick Davies (12:52):
Absolutely. So you’re absolutely right that a lot of the issues that crop up in DD are preventable. They can be prevented before you get to a sale process. And quite often we find that if we give someone who’s thinking of selling their business a due diligence questionnaire, or a set of sample warranties… And probably 90% of most warranties are fairly generic, so you can look at something which is going to be similar to any buyer is going to produce.

Who Drafts Warranties, Representations & Indemnities?

Nick Davies (13:18):
But in terms of who drafts them, a buyer or buyer’s legal advisor would normally produce the first draft of the share sale and purchase agreement, because what they’re saying there is, “We want to buy your company, and these are the terms on which we’re prepared to do it.” That SPA will include their warranties that they want. As I’ve said, a lot of those warranties will be generic and will be fairly typical, but where the buyer has done a good due diligence exercise, they may have spotted or highlighted certain areas of risk which they feel warrant or… Sorry, excuse the pun there, which require additional warranties, which are more detailed on those specific issues. Or if the risk is so great, they may say, “Well, actually this justifies and requires an indemnity.”

Nick Davies (14:01):
So the buyer will do the first hash of the draft of those. The seller’s legal advisors will look at it and say, “Well, actually that warranty’s too broad. We want to narrow the language slightly,” or, “That indemnity needs to be subject to a cap.” In some cases you may be able to say, “We can go away and fix that issue, and if we fix the issue, you don’t need the indemnity.” And I think that’s preferable, because anything you can do to de-risk the transaction and de-risk the documentation is in the seller’s interests

Warranty and Indemnity (W&I) Insurance

Justin Levine (14:29):
Thank you for that. One final topic briefly is insurance to cover for warranty and indemnity. I mean, it’s available on the open market, so that a seller can go and purchase insurance to protect them against potential claims. In my experience in the SME space with deals at sort of £10, £20, £30 million, I’ve yet to see a seller engage in it. What’s your personal view?

Nick Davies (14:55):
W&I insurance is supposedly increasing in popularity. I think you’re right. I think at the SME level, it’s rare. We have done deals which have included W&I insurance. It’s available to both buyers and sellers actually, which is quite interesting. At the SME level, it’s quite expensive, I think in my view, and often the exclusions from it are quite extensive. So, a lot of the known issues might not be covered, but it depends in each case on the terms of the insurance. But it’s something people should look at, and we can help people look at if they are nervous or concerned about risk, but it’s not something we are seeing on every deal or even regularly really. So, it’s not too popular at that SME level.


Justin Levine (15:43):
So thank you, Nick. I think what I’ve taken from this, but it’s also we’ve done a lot of projects together, is that when you sell a business, you have a sale and purchase agreement. It’s comprehensive, very detailed, a seller is asked to give warranties, indemnities, maybe representations. And from my side, as a reasonably experienced commercial person, you need a very experienced legal guide to go through it. Otherwise, it would be almost impossible to navigate that process. So thank you for your input.

Nick Davies (16:11):

Justin Levine (16:11):
And we’ll catch you on next video.

Nick Davies (16:13):
Look forward to it. Thanks, Justin.

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