Dealing with a breach of warranty when purchasing a business

Businesses and companies may often have attendant problems that may not be readily visible or even readily discoverable. For example, there may be potential legal claims against the business in the works, which the business owner does not want to disclose for fear that it will scupper the deal. If anyone buys that business, they also inherit all those problems regardless of the fact that they may be latent.

Someone buying a business cannot rely on any statutory consumer protections; instead, the rule is ‘caveat emptor’ or ‘buyer beware’. All business buyers want some comfort that they are buying what they thought they were buying and have some protection against any problems which manifest after they buy. This is where warranties come in.

What are warranties?

If you have ever bought a new car or a household appliance, then you may well have been offered a warranty to go with it. The same thing can be offered to a business buyer by the business owner. Basically, a warranty is a statement (or even a series of statements) that confirm and ‘warrant’ that the representations that the owner has made about the business are true and correct to the best of the owner’s knowledge and belief.

However, unlike buying a car or a washing machine, someone buying a business cannot rely on the warranty alone. In addition, the buyer must also carry out ‘due diligence’ on the business – a process of investigation and verification of the business and all its aspects and usually conducted by the buyer’s professional advisors. The purpose of the warranty is to complement the due diligence, not stand instead of it.

Business sale warranties are usually contained in the body of a share purchase agreement, if the buyer is acquiring the whole company, or in asset sale agreement in cases where the buyer is merely purchasing the assets of a company. Both types of agreement are customarily accompanied by a ‘disclosure letter’ in which the seller sets out all their claims about the business or asset being sold.

Either way, the warranty forms part of a contract and so is legally enforceable.

Has the warranty been breached?

The purpose of the warranty is to reassure the buyer of a business that they have bought what they thought they were buying. If that turns out not to be the case, then the buyer may believe that there has been a breach of the warranty. But, ascertaining whether or not there has, in fact, been a breach is not quite as straightforward as it first appears. Quite a few steps need to be taken first.

• The buyer needs to carefully check the precise wording of the warranty. The nature and extent of each warranty is determined by the wording, so this is a crucial factor.
• Check the disclosure letter very carefully to ensure that the problem was not, in fact, disclosed. If it was, then there is no breach. For example, a share purchase agreement warranty might state that the business has no outstanding disputes, subject to the disclosure letter. So, if the disclosure letter reveals an outstanding dispute, there is no breach.
• Check whether there is any limitation period applicable. It’s very common for a strict time limit for bringing any claims. This is usually much shorter than any statutory time limits, say 12 or maybe 24 months. If there is a time limit, check whether it runs from the date of the warranty or the date when any breach becomes apparent.
• Determine what loss has been suffered. In warranty breach cases, damages are usually calculated as the difference between what the buyer paid for the company and the price the buyer would have paid had they known about the defect which is the subject of the claim. In some cases, this may require expert evidence to be adduced.

Making a breach of warranty claim

Before any claim is brought, the purchase agreement must, again, be checked carefully. First of all, purchase agreements often contain a clause that requires a buyer to first notify the seller of any claim of breach of warranty. If such a requirement exists, then it must be fulfilled.

Serving notice on the seller provides the seller with an opportunity to remedy the breach or, if the breach cannot be remedied, then offer negotiations with a view to reaching some manner of settlement.

A purchase agreement may also provide that, in the event of a dispute or a breach of warranty claim, the matter should be settled by arbitration or referred to mediation before arbitration. If the agreement so specifies, then the buyer cannot simply issue a claim in the court right away. Instead, the stipulations of the agreement must be followed.

If anyone who has bought a company feels that they may have a claim for breach of warranty, then it is essential that they seek professional, experienced legal advice before taking any further steps. Plunging ahead without proper legal guidance can lead to very costly errors.

For further information and trusted legal advice regarding a breach of warranty, get in touch with us at Carlsons Solicitors.