M&A
What seller limitations of liability are normal in a share purchase agreement?
In M&A transactions, particularly in share purchase agreements ("SPA"), the limitation of liability (so called caps) for breaches of warranties is a crucial, and often highly negotiated, matter. The cap varies depending on the type of warranty, the deal size, jurisdiction, and the relative bargaining power of the parties. Therefore, it is helpful to know what can be considered as market practice or at least fairly common in order to know how to best navigate the negotiations, and know when to accept and when to refute a proposal from your counterparty.
Here's an overview based on both general market practice and specific trends seen in Swedish and broader European transactions.
What are warranties?
Warranties are statements of fact made by the seller (and also some by the buyer), in the share purchase agreement, with focus on the condition of the company being sold. They aim to give the buyer verification of its picture of the company’s legal, financial, and operational status at the time of sale.
Examples:
"The company has no undisclosed liabilities."
"All material contracts are valid and enforceable."
"The company owns all registered intellectual property rights."
The warranties serve to give the buyer an extra layer of protection given that the seller will always, when signing the share purchase agreement and during the negotiation of the price, have an information advantage. This is so even if the buyer has done a diligent due diligence. If a warranty turns out to be false and the buyer suffers a loss, the buyer may claim damages for breach of warranty. However, the buyer must usually prove a breach and demonstrate a loss that was due to the breach, in order to get damages. The warranties will furthermore, to reduce the risk and liability for the seller, have caps on them.
Save as has been fairly disclosed
The warranties will, in almost all cases, only cover what the buyer should not already know based on the due diligence (the investigation of the company) that the buyer has done prior to signing of the SPA. Hence there will normally be a clear carve-out that the buyer may not claim breach of warranty in relation to what has been "fairly disclosed" by the seller. The detailed description of what is included in "fairly disclosed" is therefore very important. Will it only be what is in the data room? Will it be all verbal and written communication during the due diligence? The broader the scope the more seller friendly and vice versa. (In many cases, the buyer is prevented from seeking damages for issues that the buyer know about even if they are not "fairly disclosed". For issues known to the buyer the normal protection will be through specific indemnities.)
General Commercial Warranties
The majority of the warranties will be focused on the business and operational aspects of the target company. These cover typical operational aspects like contracts, employees, compliance, IP, etc.
For such warranties there will typically be a cap on the sellers liability of around 10 - 30 % of the purchase price. In Swedish SME deals the typical cap will be somewhere in the middle, around 15-25 %. When it comes to bigger and more mature businesses and also for cross-boarder deals the cap will often be lower.
Fundamental Warranties
Some of the warranties are focused on the core aspect ot the share purchase such as the seller warranting that it has title to shares, capacity, authority, and ownership and that the target company is duely incorporated.
For such fundamental warranties the most typical cap will be 100 % of the purchase price.
Tax Warranties
Tax warranties will often be seen as a separate class, but will have the same cap as business warranties. However, the duration will as a rule be much longer (see below).
Indemnities
If the buyer has found issues during the financial and legal due diligence (no company is perfect in all aspects) then this will be handled separately. The warranties will, as stated above, typically not cover what has been fairly disclosed during the due diligence, so the buyer cannot rely on the warranties as regards such identified problems. This is where the specific indemnities come in. These are promises to compensate the buyer for specific known risks or liabilities that are described in the share purchase agreement.
Examples:
"The seller indemnifies the buyer for any tax liabilities arising from an ongoing tax audit initiated on [xx date]."
"The seller indemnifies the buyer for any environmental claims relating to a contaminated site [xx] in accordance with audit notification [xx]."
Unlike warranties, indemnities allow the buyer to recover losses on a SEK for SEK basis without having to prove breach of warranty and causality.
Cap on specific indemnification
Typical cap will be either the estimated potential loss, or only up to 100% of purchase price as part of a general liability cap for breaches against the share purchase agreement as a whole. This means that the buyers right to damages will often be stronger in relation specific issue they have identified, during the due diligence compared to when they want to rely on a more general warranty. (Note that specific indemnities will not be subject to the "basket" or "de minimis"
that are described below.)
Time Limits
Not only will the warranties have a cap in relation to the amount, they will also have limitation in time - i.e. for how long a buyer can rely on the warranty and turn to the seller with a claim.
The typical time limits are as follows:
General warranties: 12–24 months.
Fundamental warranties: Up to 7–10 years.
Tax warranties: Usually aligned with statute of limitations (typically 5–7 years).
Baskets
In addition to caps and time limits, many SPA:s also provide for so called "de minimis" and "basket" provisions. These entail that claims need to be of a certain size in order for the buyer to be entitled to any compensation from the seller. (So that the buyer will not come after the seller for any tiny issue and tine amount post closing.)
These limitations of libaility are hence known as baskest, tipping basket or de thresholds:
A single claim must exceed a certain amount (de minimis).
Claims only payable once a collective number of issuet, i.e. a basket threshold is met (e.g., 2% of purchase price). This will be the so called tipping basket, which means that once the threshould amount has been met the buyer gets compensated for the full amount.
Practical Tips
The negotiation positions for the buyer and seller should be rather clear. As regards the buyer; seek higher caps for key risks. And make sure to separate general, fundamental, and tax warranties and ensure that not more than needed is included in the fundamental warranties. If you are the seller; push for low caps, short time limits the negotiations, make.
Do you have any questions as regards M&A? Please feel free to reach out.
London, 12 July
Author; Kat Strandberg
What are warranties?
Warranties are statements of fact made by the seller (and also some by the buyer), in the share purchase agreement, with focus on the condition of the company being sold. They aim to give the buyer verification of its picture of the company’s legal, financial, and operational status at the time of sale.
Examples:
"The company has no undisclosed liabilities."
"All material contracts are valid and enforceable."
"The company owns all registered intellectual property rights."
The warranties serve to give the buyer an extra layer of protection given that the seller will always, when signing the share purchase agreement and during the negotiation of the price, have an information advantage. This is so even if the buyer has done a diligent due diligence. If a warranty turns out to be false and the buyer suffers a loss, the buyer may claim damages for breach of warranty. However, the buyer must usually prove a breach and demonstrate a loss that was due to the breach, in order to get damages. The warranties will furthermore, to reduce the risk and liability for the seller, have caps on them.
Save as has been fairly disclosed
The warranties will, in almost all cases, only cover what the buyer should not already know based on the due diligence (the investigation of the company) that the buyer has done prior to signing of the SPA. Hence there will normally be a clear carve-out that the buyer may not claim breach of warranty in relation to what has been "fairly disclosed" by the seller. The detailed description of what is included in "fairly disclosed" is therefore very important. Will it only be what is in the data room? Will it be all verbal and written communication during the due diligence? The broader the scope the more seller friendly and vice versa. (In many cases, the buyer is prevented from seeking damages for issues that the buyer know about even if they are not "fairly disclosed". For issues known to the buyer the normal protection will be through specific indemnities.)
General Commercial Warranties
The majority of the warranties will be focused on the business and operational aspects of the target company. These cover typical operational aspects like contracts, employees, compliance, IP, etc.
For such warranties there will typically be a cap on the sellers liability of around 10 - 30 % of the purchase price. In Swedish SME deals the typical cap will be somewhere in the middle, around 15-25 %. When it comes to bigger and more mature businesses and also for cross-boarder deals the cap will often be lower.
Fundamental Warranties
Some of the warranties are focused on the core aspect ot the share purchase such as the seller warranting that it has title to shares, capacity, authority, and ownership and that the target company is duely incorporated.
For such fundamental warranties the most typical cap will be 100 % of the purchase price.
Tax Warranties
Tax warranties will often be seen as a separate class, but will have the same cap as business warranties. However, the duration will as a rule be much longer (see below).
Indemnities
If the buyer has found issues during the financial and legal due diligence (no company is perfect in all aspects) then this will be handled separately. The warranties will, as stated above, typically not cover what has been fairly disclosed during the due diligence, so the buyer cannot rely on the warranties as regards such identified problems. This is where the specific indemnities come in. These are promises to compensate the buyer for specific known risks or liabilities that are described in the share purchase agreement.
Examples:
"The seller indemnifies the buyer for any tax liabilities arising from an ongoing tax audit initiated on [xx date]."
"The seller indemnifies the buyer for any environmental claims relating to a contaminated site [xx] in accordance with audit notification [xx]."
Unlike warranties, indemnities allow the buyer to recover losses on a SEK for SEK basis without having to prove breach of warranty and causality.
Cap on specific indemnification
Typical cap will be either the estimated potential loss, or only up to 100% of purchase price as part of a general liability cap for breaches against the share purchase agreement as a whole. This means that the buyers right to damages will often be stronger in relation specific issue they have identified, during the due diligence compared to when they want to rely on a more general warranty. (Note that specific indemnities will not be subject to the "basket" or "de minimis"
that are described below.)
Time Limits
Not only will the warranties have a cap in relation to the amount, they will also have limitation in time - i.e. for how long a buyer can rely on the warranty and turn to the seller with a claim.
The typical time limits are as follows:
General warranties: 12–24 months.
Fundamental warranties: Up to 7–10 years.
Tax warranties: Usually aligned with statute of limitations (typically 5–7 years).
Baskets
In addition to caps and time limits, many SPA:s also provide for so called "de minimis" and "basket" provisions. These entail that claims need to be of a certain size in order for the buyer to be entitled to any compensation from the seller. (So that the buyer will not come after the seller for any tiny issue and tine amount post closing.)
These limitations of libaility are hence known as baskest, tipping basket or de thresholds:
A single claim must exceed a certain amount (de minimis).
Claims only payable once a collective number of issuet, i.e. a basket threshold is met (e.g., 2% of purchase price). This will be the so called tipping basket, which means that once the threshould amount has been met the buyer gets compensated for the full amount.
Practical Tips
The negotiation positions for the buyer and seller should be rather clear. As regards the buyer; seek higher caps for key risks. And make sure to separate general, fundamental, and tax warranties and ensure that not more than needed is included in the fundamental warranties. If you are the seller; push for low caps, short time limits the negotiations, make.
Do you have any questions as regards M&A? Please feel free to reach out.
London, 12 July
Author; Kat Strandberg