In mergers and acquisitions (M&A), warranties and indemnities are fundamental tools used to allocate risk between buyer and seller. While they are often used together in legal agreements, each serves a different purpose.
In this guide from Altius Corporate Finance, we explore what they mean, how they work, and why they matter.
Why are Warranties and Indemnities Required?
In any M&A deal, the seller is the party responsible for providing warranties and indemnities. These are legally binding commitments concerning various aspects of the business being sold. The buyer, in turn, holds the responsibility of exercising or enforcing them if any issues arise following completion.
Buyers rely on these tools to understand what they are acquiring and to seek redress if key information turns out to be inaccurate or incomplete. Sellers use them to define the limits of their liability and protect themselves from post-sale claims.
What are Warranties in M&A?
Warranties are contractual assurances given by the seller about the condition of the business at the time of sale. These statements are designed to give the buyer confidence in the accuracy of the information provided and the integrity of the business.
Typical warranties may relate to financial accounts, legal compliance, tax status, employees, assets, or any other area deemed important. If a warranty proves to be false, the purchaser may have grounds to file a claim for breach of contract and pursue monetary damages.
For example, the seller might warrant that the business is not subject to legal proceedings, that its financial statements are accurate, or that there are no outstanding tax liabilities.
Types of Warranties
Warranties can be broad or highly specific, depending on the transaction, but common categories include:
Tax Warranties: These confirm that the business has complied with all applicable tax laws and paid all taxes due up to completion. This includes corporation tax, VAT, PAYE, National Insurance and any other relevant obligations. The seller may also confirm that there are no ongoing investigations or disputes with HMRC.
Financial Warranties: These cover the accuracy and completeness of the company’s accounts and financial position. The seller might warrant that the accounts present a true and fair view, that there has been no material deterioration in financial health, and that the company is solvent.
Operational Warranties: These relate to the routine operations of the company. Examples include confirmation that key contracts with suppliers and customers are valid, that licences and permits are in place, and that no senior staff have resigned or indicated plans to do so.
Legal Warranties: These typically assert that the company is properly incorporated, owns its assets free of undisclosed encumbrances, and is not involved in litigation. Legal warranties may also cover intellectual property, employment compliance and adherence to regulatory requirements.
Environmental Warranties: These are especially relevant in industries with potential environmental risks. They confirm that the business complies with environmental laws and that its operations do not pose contamination risks or require remediation.
What are Indemnities in M&A?
Indemnities are a form of contractual protection in which the seller agrees to compensate the buyer for specific losses or liabilities that may arise post-completion. Unlike warranties, which provide general assurance, indemnities are used to address known or clearly defined risks.
These may include ongoing litigation, unpaid taxes, or a specific environmental issue. If the indemnified event occurs, the buyer is entitled to pound-for-pound compensation, regardless of whether the loss results from a breach of warranty.
Indemnities are particularly useful when a risk has been identified during due diligence, but the buyer is still willing to proceed with the deal, provided that financial protection is in place. The scope, limitations and duration of indemnities are typically negotiated in detail during contract drafting.
Which Legal Documents Include Warranties and Indemnities?
These provisions are usually found in the Sale and Purchase Agreement (SPA). This is the principal legal document in an M&A deal, setting out the terms of the sale, including price, payment terms, conditions precedent and post-completion obligations. To read more about Sale and Purchase Agreements, go here.
Unlike preliminary documents such as Heads of Terms or Letters of Intent, the SPA is legally binding. Depending on the structure of the deal, the SPA may be referred to as a Share Purchase Agreement (for share sales) or an Asset Purchase Agreement (for asset sales).
How are Disputes Resolved?
If a dispute arises concerning a warranty, indemnity or representation, the matter is typically resolved through legal proceedings or arbitration. In the United Kingdom, such claims are generally heard in the High Court or the Commercial Court, depending on the nature and complexity of the issue.
The court will examine the relevant documentation and assess whether a breach or misrepresentation has occurred, and what compensation, if any, should be awarded. Arbitration may be used as an alternative to litigation, offering confidentiality and potentially faster resolution.
The Role of Warranty and Indemnity Insurance in M&As
Warranty and indemnity insurance can be a feature in M&A deals, designed to shift the financial risk of potential claims from the buyer or seller to an insurer.
Either party – buyer or seller – can arrange for this insurance cover. For buyers, it provides added protection and may allow them to pursue claims directly against the insurer rather than the seller. For sellers, it offers a cleaner exit by reducing or eliminating the need to ring-fence funds for future claims.
W&I insurance can also make a bid more attractive in competitive situations by removing the requirement for extensive seller guarantees. It helps preserve confidentiality by handling claims privately, and it is especially valuable in deals involving distressed businesses, complex ownership structures, or sellers with limited ability to meet potential liabilities.
Additionally, warranty and indemnity insurance can help maintain goodwill between the parties, particularly in transactions where the seller will remain involved in the business post-sale, such as management buyouts or joint ventures.
The Right Partner in M&A – ACF
In any M&A transaction, understanding the role of warranties and indemnities is essential for managing risk and protecting your position. For sellers, these provisions can define the boundaries of post-sale liability. For buyers, they offer critical safeguards and recourse should issues arise after completion.
At Altius Corporate Finance, we support both buyers and sellers throughout the deal process, helping to anticipate risks and negotiate favourable terms. We can recommend an experienced legal adviser or will work alongside your lawyer throughout the sale process to ensure your transaction is professionally managed from start to finish. Whether you’re preparing for a sale or actively acquiring, our team is here to help you approach each stage of the deal with confidence.
