UK: Warranty Limitations: 5 Essential Ingredients

Last Updated: 20 March 2019
Article by Andrew Mills, Emmanuel Amos and Ryan Brown

In this article, we focus on the limitations on liability typically applied to potential warranty claims under a sale and purchase agreement (SPA). The limitations act as both a safety net for sellers and to provide clarity to buyers as to how, when and against whom a claim can be brought. Any negotiation on this topic inevitably revolves around what is "market practice", and we set out below what we have been seeing in five key areas in the last 12 months. In this article we assume all sellers are providing a full suite of warranties in the SPA.

1. Watching the Clock – Time Limits

Warranties are typically separated into two distinct categories – fundamental warranties (also known as cornerstone or key warranties) and business warranties (also known as commercial warranties). Fundamental warranties go to the heart of the transaction, e.g. confirming that the seller has title to the sale shares and authority to sell them. The business warranties cover the operational aspects of the target company, and for the purposes of limitations are often split between two sub-categories: those relating to tax and those covering other aspects of business operations.

The time limits for breach of fundamental and tax warranties are fairly standard; typically there is no time bar on bringing a claim for a breach of fundamental warranty, and the time limit for bringing tax warranty claims tracks HMRC's longest (non-fraud) review period, seven years.

The time limit applicable to non-tax business warranties (e.g. that the target is not party to any litigation) is more contentious. MJ Hudson's latest deal terms review (to be published later in 2019) revealed a wide range from 6 to 24 months from completion. The average time limit for business warranty claims was 18 months from completion, but a period linked to financial year ends was also popular (e.g. time limit of 6 months after the next financial year end after completion).

2. Caps and Hurdles – Financial Limits

Sellers will want certainty as to their maximum exposure under the SPA, a concern that is always accommodated but subject to considerable negotiation.

Upper limits

Liability for breach of fundamental warranties is typically capped at the entire purchase price paid to the sellers. Tax warranties may be treated the same way, or liability may be uncapped. Unsurprisingly given their broad subject matter, the caps applicable to non-tax business warranties are the most contentious. The seller-friendly M&A environment that has prevailed (despite the financial crisis) over the last two decades has put liability caps under continuous pressure, and our deal terms review revealed an average cap of just over 50% of purchase price, with 25% and 75% being the lower and upper ranges respectively. However it is worth noting that, on smaller value deals, the total liability cap is likely to be much closer to the entire purchase price, as the buyer will want recourse against a minimum cash amount that is sufficient to remedy problems identified.

Lower limits

Sellers will also want protection against the buyer bringing immaterial, low value "nuisance" claims. In the UK, it is market practice to agree two lower limits; a 'de minimis' that acts to filter out all potential claims below a certain value, and a 'threshold' (or 'basket') ensuring that claims are only actionable once a number of above 'de minimis' claims have been aggregated. (In the US it is more common to see only the 'threshold'.)

In small to mid-cap deals the de minimis limit is typically between 0.1% and 0.5% of the aggregate purchase price, with our review returning an average of 0.25%. The 'threshold' is commonly between 1% and 3% of aggregate purchase price; in our review the average threshold was 1.6%. A separate ingredient to the 'threshold' limitation is whether, once the threshold has been reached, the aggregate of all qualifying (above de minimis) claims should be recoverable, or just the excess. In UK deals the entire amount, and not just the excess, is usually recoverable (US practice can differ).

3. Individual Caps and Liability Splits

Individual vs group liability (among the sellers) can also be a hot topic, and a lot rests on whether the sellers are now going to be working together as the management team driving a PE-backed business, close associates who see value in banding together, or unconnected investors who shudder at the thought of sharing any liability of the others.

Individual caps

However the sellers are categorised, each will seek to cap its total liability for all warranty claims (excluding fraud etc.), typically at the total purchase price actually received.

Joint and several liability

A buyer would always prefer the sellers to be "jointly and severally liable", i.e. it can pick and choose which seller(s) to bring a claim against, and can (subject to any individual cap) claim 100% of the value of the claim from those it wishes to pursue. This would, for example, allow a buyer to pursue only a seller with deep pockets. Private equity buyers often insist on joint and several liability as they see the sellers (often being their future management team) as a single block who should be confident in the accuracy of the warranties they are giving in respect of the company they own.

From a seller's perspective, it may be preferable to be severally liable only (i.e. a buyer would have to bring any claim against all sellers, and not target specific individuals). If several liability is agreed, the next question is how they are severally liable, e.g. are certain sellers responsible only for certain warranties, or are all sellers responsible only for a specified percentage of the amount of any claim.

In our review the majority of sellers agreed to joint and several liability.

Musketeer clauses

Sellers (particularly if the sellers form the ongoing management team) have also been known to request a clause providing that a claim is only valid if brought against all sellers. From a seller's/management team's perspective this provides comfort that they will stand together in the event of a claim, and that the prospect of bringing a claim against all sellers/the entire management team could dissuade the buyer from bringing a claim at all.

4. Brakes on Recovery

In an SPA, the various caps, hurdles and mechanisms outlined above are often followed by what might appear to be 'boilerplate' clauses. However these typically go beyond regulating mere process – some key provisions to watch out for are summarised below.

Buyer's knowledge

Due diligence, and the disclosure process against warranties, serves to flush out information which shapes the buyer's decision to buy, and on what terms (including price). Therefore the seller will argue that it is unfair for the buyer to be able bring a claim if, at the moment of completion, the buyer is actually aware of circumstances that constitute a breach of warranty. In our experience most sellers will seek to include this clause on their first turn of the SPA.

Conduct of claims

If a third party brings any claim against the target company, the sellers might ultimately become liable if the buyer seeks to recover lost value in a subsequent warranty claim. Sellers will therefore typically want an option to take conduct of such claims (in order to protect themselves, indirectly), or at least to be consulted or informed of the status of those claims. This is often hotly debated, as the buyer will not want to cede control over third party disputes that could impact on relationships and reputation. A typical compromise position might fall short of granting the sellers conduct, but could entail consultation and some restrictions on settling any claim without input from the sellers.

Recovery from third parties and under insurance

If the target company suffers a loss, the sellers would ideally want it to exhaust all options to recover that loss from third parties (including under insurance), before bringing a warranty claim against the sellers. A buyer will understand the sellers' concern, but will want to make good the loss as soon as possible, rather than having to pursue third parties or a complex insurance process for an extended period (and will certainly not want to be 'timed out' of bringing a warranty claim in the meantime). In our experience negotiation typically results in a compromise whereby third party and insurance claims must be prioritised for a specified period only, or pursued in parallel with any warranty claim.

5. Mitigation

The typical remedy for a breach of warranty under English law is an award of damages. However the buyer is also required to mitigate its losses, i.e. take reasonable steps to reduce or avoid the losses. Even though this is a feature of common law, sellers will (in our experience, always) demand an express provision in the SPA, providing a clear reminder a buyer of the duty to mitigate and in effect acting as a limitation to prevent the buyer recovering any losses it could arguably have avoided.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions