Warranty Limitations: 5 Essential Ingredients

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...