Limitations on a seller's liability are among the most frequently negotiated issues in share sale and purchase transactions. Both sellers and buyers aim to safeguard their interests, resulting in various limitations that can significantly impact the outcome of warranty claims. This article examines the scope of these limitations under English law, the implications of exclusions, and common negotiation positions that ultimately become part of a share purchase agreement (SPA).
What are Warranties?
Warranties in an SPA are assurances made by the seller regarding specific aspects of the business or assets being sold, such as their condition, legal compliance, financial status, or other critical factors.
If a seller breaches a warranty it has provided, the buyer may be entitled to claim damages for breach of contract. This could involve compensation for incurred losses or a reduction in the purchase price, depending on the agreement's terms and the specific nature of the breach.
By limiting their liability under a SPA, sellers aim to manage their exposure to potential claims, making their financial responsibilities predictable and manageable. Meanwhile, these limitations also encourage buyers to conduct thorough due diligence.
Financial Limitations on Claims
Financial Cap on Claims
Sellers generally aim to set a maximum limit on their liability for warranty claims, while buyers often prefer no limits. Typically, a cap is agreed upon after negotiations. Sellers usually assert that their maximum liability should not exceed the purchase price of the shares and, in some cases, may seek a cap lower than the total purchase price. In certain instances, caps can exceed the purchase price, depending on the deal's terms.
De Minimis
To reduce disruption from minor claims (i.e. which are immaterial compared to the agreed purchase price), sellers often propose an "individual de minimis" threshold, allowing warranty claims below a certain financial value to be ignored.
In practice, Buyers commonly accept the inclusion of an individual de minimis threshold for warranty claims, while no such limit applies to indemnity or tax covenant claims.
Claims Basket
Sellers frequently propose a "basket" threshold for aggregate claims alongside individual de minimis limits. This stipulation requires warranty claims to surpass a predetermined financial threshold (i.e. when the claims basket is full) before they can be pursued.
It is also important for parties to agree on how the basket threshold would operate. A basket may be categorised as a “tipping basket” or a “true deductible”. A tipping basket allows the entire amount to be claimed once the total exceeds the agreed threshold. In contrast, with a deductible basket, only claims that surpass a specified amount can be submitted, meaning only excess claims are enforceable.
Individual Caps for Multiple Sellers
In transactions involving multiple sellers, buyers often retain the right to recover the full amount from any seller (either jointly or separately), which can result in a seller being liable for more than their share. To mitigate this risk, sellers may seek individual caps on liability, ensuring their exposure does not exceed their pro rata share of the purchase price. However, buyers typically resist these caps, preferring to avoid risks associated with untraceable sellers or those lacking financial resources.
Time Limits on Claims
Time Bar Provisions
The Limitation Act 1980 sets default limitation periods for pursuing warranty claims - six years from the date of breach or 12 years if executed as a deed. However, sellers often negotiate for shorter time frames, usually achieved through a time-bar clause in SPA. These clauses require buyers to notify warranty claims within an agreed timeframe, failing which the claims may be invalidated.
Negotiations often result in cut-off periods between one to three years post-completion for general warranties, with longer periods for tax-related warranties.
Obligation to Progress Claims
Sellers may require buyers to initiate legal proceedings for a warranty claim within a specified timeframe after becoming aware of the breach. Additionally, sellers often include a provision in the SPA stating that if the buyer does not file the claim within this timeframe, they will lose the right to pursue it.
Other Limits
Seller’s Knowledge
Sellers often aim to limit their liability for warranty claims by qualifying warranties with phrases like "to the best of the Seller's knowledge and belief". This strategy helps them avoid the risk of undisclosed issues they might not be aware of. Whether buyers accept this risk allocation is negotiable and usually depends on the warranty type and transaction context. When buyers agree to such qualifications, they may want to define what "knowledge" means, as sellers typically prefer a narrow definition that excludes constructive or imputed knowledge.
Buyers, on the other hand, seek assurance that sellers are not disregarding potential problems. To address this, sellers might be required to consult specific individuals, but this can create knowledge gaps. Therefore, it's advisable for the SPA to clearly define the seller's inquiry obligations. Buyers may also want to ensure sellers are informed about matters known to key personnel.
In practice, certain warranties are often subject to the seller's awareness, where applicable. The SPA should clearly state that any reference to the seller's knowledge or awareness means the actual knowledge of the Seller, after making all reasonable inquiries with specific individuals most likely to have the requisite knowledge on the subject matter.
Conduct of Claims
Sellers may also seek post-completion rights to conduct disputes with third-parties arising out of warranty claims. Sellers argue that having a say in how claims are handled could minimize their liability due to potential conflict in motivations between the buyer and seller. Buyers, however, may resist such provisions to avoid compromising their ability to manage business-critical disputes effectively.
Third-Party Recovery
In instances where a buyer suffers a loss that could be recovered from a third-party, sellers may propose limitations that require buyers to exhaust third-party recovery procedures (e.g. insurance) before pursuing warranty claims. Buyers typically resist such provisions, as they may complicate recovery and prolong the claims process. However, many buyers are willing to accept terms that prevent double recovery if compensation from a third-party is actually received.
Duty to Mitigate
The SPA may include a provision which requires that buyers take reasonable steps to avoid or mitigate any loss or damage as a consequence of any breach by the seller of a warranty under the SPA.
Changes in Legislation
Changes to legislation following the completion (or execution, where execution and completion are not simultaneous) of the transaction under the SPA are a commonly accepted limitation on liability.
Final thoughts
A key issue arises when buyers challenge limitations on liability for specific warranties, such as those concerning the seller’s capacity, ownership, and title to shares, which are often deemed fundamental. Buyers may argue that these warranties should be exempt from any agreed limitations due to their central importance to the transaction's integrity.
Negotiating limitations on a seller's liability in share purchase transactions is complex, requiring careful consideration and balancing of interests. By understanding the various types of limitations and common negotiation points, both buyers and sellers can more effectively navigate this critical aspect of an SPA.
For more information and personalised guidance and support, please contact Jamie Tredgold, Managing Principal and Zarak Khan, Legal Director. ____________________________
This material is provided for general information only. It should not be relied upon for the provision of or as a substitute for legal or other professional advice.
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