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Key Differences Between Warranties and Indemnities in Purchase Agreements

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When purchasing a business, a purchaser relies heavily upon the contractual promises made by the seller. These promises come in the form of warranties and indemnities; but they have key differences in practice. Here Greenaway Scott considers the differences between these legal promises and the effect they have in practice.

Identifying risks

During the negotiation stage of a sale and purchase agreement, the seller must disclose everything to the purchaser. Within the purchase agreement, the seller will make a number of warranties and indemnities to the purchaser. A disclosure letter is used to outline any discrepancies with the business. The purpose of this disclosure letter is to bring to the purchaser’s attention to elements of the business which would otherwise give rise to a breach.

Warranties

Warranties are a contractual statement made by a seller that the business is being portrayed accurately. If the purchaser discovers post-completion that the business was falsely represented, the purchaser can bring a claim for breach of warranty. The disclosure letter mentioned above is used to allow the purchaser to be fully briefed on all possible breaches of warranties, which allows them to make an informed decision on whether to purchase the business and protects the seller against these claims further down the line.

Indemnities

Indemnities are used in purchase contracts, in which the seller promises the purchaser that the business is in a state that is being promised and if certain events happen which cause loss or damage to the purchaser, the seller will pay the cost of this. This is referred to as the seller promising to make good a loss or damage which the purchaser may suffer for their breach of contract.

Warranties v Indemnities

The key difference between these legal promises is the enforcement mechanism for the purchaser. Following completion, if the purchaser discovers that the seller has in fact breached a warranty, they are able to make a claim for damages. As this suggests, this may be long and expensive process as lawyers would need to be instructed to bring a claim in the courts and it may take an extended period of time to recover the damages. In comparison, where there has been a breach of indemnity, the purchaser is able to recover the costs without making a claim. This is due to the seller already making a promise that if any loss or damage is caused by the breach of contract, they will pay the cost of it. As a result, the lengthy and expensive process of bringing a claim is not needed. In practical terms, a purchaser limits their risks if they request indemnities rather than warranties in the purchase agreement.

To summarise the above, warranties and indemnities are legal assurances made to the purchaser of a business that they are purchasing what is being represented. A purchaser is protected to a higher extent with an indemnity as they will recover costs without having to issue court proceedings for the breach. This said, sellers are always cautious to offer too many indemnities as they need to limit the risk of paying out for costs. In reality, contracts often contain a mixture of warranties and indemnities and onerous on the purchaser whether they accept the legal promises for the business they are obtaining.