Guarantees and Indemnities

Guarantees and indemnities are a common and essential part of business acquisition negotiations. These indemnities are included by the buyer in the purchase agreement and are primarily intended to ensure that the risks involved in a business acquisition are distributed correctly between the buyer and seller. What guarantees are included and what risks are protected by an indemnity? And what happens if the indemnity is breached? Our corporate law attorneys have extensive experience in this area and can provide you with some information.

Risks for the buyer and seller

There are many risks for both the buyer and the seller in a business acquisition. In an acquisition, an attempt is made to identify these risks in advance by conducting due diligence. This audit reveals risks, which can then be assessed. This is important for the contract negotiations in which the price is determined, but also which terms and conditions apply. The seller wants to avoid any hassle after the sale and to obtain the highest possible sale price. The buyer wants to be protected against losses and liabilities after the purchase. The parties can work out these risks in guarantees and indemnities.

What is a guarantee in a company acquisition?

A guarantee in a company acquisition is a statement by the selling party about the state of the company at the time of sale or on a specific date.

Examples of warranties that are included in the warranties and indemnities in the acquisition contract are, for example:

• That the balance sheet has been prepared correctly

• That there are no unknown (legal) claims

• That the data on the personnel is correct

• That the property belongs to the company and has not been pledged or seized

• That all information provided is correct

Breach of contract and liability

If one or more warranties prove to be incorrect, the seller is in default. This constitutes a breach of contract and the seller must compensate for the resulting damage. When establishing warranties and indemnities, agreements are often made about the extent of the seller’s liability. Agreements may also be made about the minimum amount of claims or a maximum period during which the purchasing party can submit a claim. The purpose of damages under a breach of warranty is to place the innocent party in the position it would have been in if the warranty had been valid.

What is an indemnity in the acquisition of a company?

An indemnity is a contractual commitment by one party to cover any liability and compensate another party for any loss suffered. In the context of mergers and acquisitions, indemnities are often used to cover specific issues identified during the buyer’s due diligence investigation. These issues constitute a known risk or problem, which is usually borne by the selling party.

Examples of indemnities that may be part of warranties and indemnities in the acquisition of a company include:

• Ongoing proceedings by a creditor

• A dispute with the tax authorities

• A product defect

• Soil contamination already known to the selling party

Indemnity statement

Although the risk or the amount of damage is not yet known, the parties involved can agree within the warranties and indemnities in the acquisition contract on what will happen if the problem materializes or if the amount of damage becomes known. This is done with a declaration of indemnity. The parties agree that the seller will bear this specific risk and compensate the selling party or the company itself for the consequences. Indemnities are also a distribution of risk. Unlike warranties, however, indemnities concern risks that are already known to the parties.

The difference between guarantees and indemnities

Guarantees and indemnities are very similar, but when it comes to contractual arrangements and the recovery of costs, there is a difference. Indemnities provide a distribution of risk that is already known or is a foreseeable risk (based on the additional effect of reasonableness and fairness). This means that there is no need to first prove a breach or default. In principle, the acquisition contract clearly states who is responsible for these costs. In the case of a guarantee when acquiring a company, it must first be established (in principle by the buyer) that there has been a breach of guarantees. The buyer must then claim compensation. The type of damage the buyer can claim, and how, is usually set out in detail in the acquisition agreement.

Breach of warranties and indemnities in a company acquisition

In the case of a company acquisition, it is crucial to understand when there has been a breach of warranties and indemnities – and more importantly, what the consequences of this are. A breach of warranties and representations occurs when information or statements provided by the selling party regarding the company to be acquired prove to be incorrect or incomplete. This can range from information about financial figures and profitability to the state of assets and liabilities, the concealment of debt, incorrect information about permits, and even legal issues. Promises or commitments made about the company that prove to be incorrect after the acquisition are also considered a breach of warranties and conditions.

What are the legal consequences of breaching an indemnity in a company acquisition?

When an indemnity is breached in a company acquisition, this has immediate legal consequences. The seller is obliged to fully compensate the buyer for any damage and/or costs arising from the agreed risk, without there first having to be a contractual breach. This distinguishes an indemnity from a warranty. If the risk becomes a reality, the buyer can immediately invoke the indemnity clause and claim compensation. Due to the possible consequences of a breach of an indemnity, it is important to formulate the indemnities very carefully in the purchase agreement.

Drafting an indemnity clause

To manage such situations, including a comprehensive indemnity clause in the acquisition contract is an essential part of the business acquisition. This clause protects the buyer against financial losses resulting from breaches of warranties and indemnities by the seller, or in legal terms: indemnifying liability. Drafting a model liability indemnity is a common practice to limit liability and specify which claims for damages are covered by the indemnity. Understanding and effectively managing breaches of warranties and indemnities is critical to ensuring a smooth business acquisition and minimizing financial risks.

Warranties and indemnities examples

Warranties and indemnities in a business acquisition refer to specific legal and financial agreements made between the buyer and seller as part of the acquisition process. These are usually included in the indemnity clause. An example of an indemnity in an indemnity agreement is an indemnity against hidden debts. To provide a complete picture, we have listed a number of general and common examples of warranties and indemnities.

Examples of warranties include:

• Financial warranties: the seller warrants that the company’s financial statements are true and complete, with no hidden debts or irregularities.

• Asset and liability warranties: the seller warrants that all assets listed in the acquisition agreement are indeed owned by the company and that there are no unknown liabilities, such as hidden debts or unpublished legal obligations.

• Contract warranty: the seller guarantees that all of the company’s current contracts are valid and binding and that there are no violations or disputes that could affect the contracts.

• Tax warranty: The seller warrants that all tax returns have been filed correctly and that there are no outstanding tax claims, such as unpaid taxes or penalties.

• Ownership warranty: The seller warrants that the company is free from intellectual property claims and that there is no infringement of third-party intellectual property rights.

Examples of indemnities may include:

• Indemnity against hidden debts: if hidden debts come to light after the acquisition, the seller may be required to indemnify the buyer for the financial consequences of these debts.

• Indemnification against legal disputes: if there are pending or future lawsuits relating to a specific event or events prior to the acquisition, the seller may be required to indemnify the buyer against losses in these cases.

• Indemnification against tax claims: if unexpected tax claims arise after the acquisition, the seller may be required to indemnify the buyer against the financial consequences of these claims.

• Indemnification against breach of contract: if a breach of contract occurs in connection with ongoing contracts after the acquisition, the seller may be required to indemnify the buyer for any damages.

Frequently asked questions about warranties and indemnities

We regularly receive questions regarding warranties and indemnities in relation to business acquisitions, as well as the drafting of an indemnity agreement or indemnity clause. We are happy to answer some of these questions.

What are warranties and indemnities?

Guarantees are commitments regarding the characteristics or quality of a product or service. Indemnities are statements that a party is not liable for certain risks or damages. In a business acquisition, guarantees are commitments about the company made by the seller. Indemnities are statements that the seller is not liable for certain risks or damages.

What is the difference between liability and indemnification?

Liability is the obligation to compensate for damage. Indemnification is a statement that a party is not liable for certain risks or damage. The difference between liability and indemnification is that in the case of liability, the seller must compensate for the damage, while in the case of indemnification, the seller is not liable for the damage.

What is a warranty in a business acquisition?

A warranty in a company acquisition is a non-defined legal concept that is included in the acquisition agreement. It represents a specific statement or promise made by the seller to the buyer about the current state or circumstances of the company being acquired. In some cases, if these warranties are breached, the buyer can claim compensation from the seller.

What is a warranty in M&A transactions?

A warranty in an M&A transaction is a commitment made by the seller to the buyer regarding the characteristics or quality of the company being acquired. A warranty may, for example, relate to the financial situation of the company, the quality of its products or services, the condition of its assets, or its legal status.

How does an indemnity work?

An indemnity in a company acquisition is a statement by the seller that they are not liable for certain risks or damages. If the seller has given an indemnity and the buyer suffers damage as a result of a risk or damage covered by the indemnity, the seller is not liable for the damage. An example of an indemnity is an indemnity for liability for damage caused by incorrect information in the financial statements.

What does indemnity from mean?

Indemnity from means that someone does not accept liability for certain risks or damage that may occur after the acquisition.

What is the Haviltex standard?

The Haviltex standard is a legal principle that is applied in the interpretation of contracts. It takes into account not only the literal wording of the contract, but also the intention of the contracting parties. This means that when assessing a contract, the court must take reasonable account of what the parties intended when they drew up the contract.

Our lawyers assist with guarantees and indemnities

Without knowledge of the type of acquisition and known facts or unknown risks, it is impossible to say in advance which guarantees and indemnities you should include in the business acquisition contract. These contractual provisions are of a legal nature and are tailor-made. The lawyers at Fruytier Lawyers in Business have extensive knowledge and are happy to assist you with a merger or acquisition. Our specialists assist you from the orientation phase and the financing of the business acquisition to the drafting of a non-disclosure agreement and advice on the acquisition of the customer base.

Our lawyers have extensive experience in guiding mergers and company acquisitions and drafting indemnity agreements. With the right legal expertise, we support both buyers and sellers in protecting their business interests and managing risks. For more information about guarantees and indemnities or the drafting and review of an indemnity clause, please feel free to contact us.