The provisions governing the liability of sellers are typically a central component of business purchase agreements. From the buyers’ perspective, these liabilities serve as the key factor in determining the purchase price. Sellers typically prefer a very limited scope of warranties. Buyers, on the other hand, seek the most comprehensive and unrestricted warranties possible.
A simple example: Sellers will typically seek to limit the warranties regarding the financial statements to compliance with generally accepted accounting principles (GAAP). Company buyers seek assurances that, apart from the liabilities disclosed in the annual financial statements, there are no additional obligations or liabilities of the company until closing. With such a strict balance sheet guarantee, the seller releases the buyer from all obligations not recognized on the balance sheet up to the closing date.
Hard Balance Sheet Guarantees
If corporate buyers succeed in securing a hard balance sheet warranty, they theoretically need only the sellers’ warranty regarding legal disputes. The remaining company-related warranties are then dispensable. The reason: A breach of the other warranties typically results in an obligation on the part of the company, which would then already constitute a breach of the hard balance sheet warranty.
2Company sellers have an interest in not being held liable for matters beyond their knowledge. This is the case, for example, when the seller cannot have knowledge of certain circumstances because they have no influence over the company’s day-to-day operations. Well-advised sellers will insist on the qualification that this is the case “to the best of their knowledge.”
Furthermore, it is advisable for business sellers to limit warranties to “material matters.” For example, a warranty could state that “all material contracts are fully in force and have not been terminated.”
Well-advised business sellers typically set liability caps at 10 to 25 percent of the sale price. This excludes matters of corporate law and tax warranties. Furthermore, business sellers should ensure that short limitation periods are agreed upon. It is not uncommon for the parties to agree on a standard limitation period of 18 months for warranty liability, as this allows the buyer to prepare the company’s annual financial statements under its own management. In practice, however, business buyers often insist on liability periods of up to five years.
If business sellers wish to avoid significant disadvantages, they would be well advised to select an advisor who possesses the necessary expertise.
