Warranties and indemnities

One of the principal ways in which a buyer will seek to protect itself in a transaction is by requiring the seller to provide warranties about the business in the business purchase agreement. If it later transpires that the warranty was inaccurate, and this causes the buyer loss, the buyer may have remedies against the seller.

The buyer can also seek to include a requirement that the seller indemnify it against any losses the buyer sustains because of a breach by the seller of a warranty or other provision of the agreement. The difference between warranties and indemnities is explained below.

What is a warranty?

Warranties are promises by the seller as to the state of affairs of their business.  If these promises are inaccurate and cause the buyer loss, the buyer may have remedies against the seller, such as a claim for damages.  Warranties encourage disclosure of information by the seller and protect the buyer against undisclosed matters or liabilities.

A warranty in a business purchase agreement is in the strict sense, as with any other warranty, merely a term of the contract itself, breach of which will give rise to damages or, in rare circumstances, rescission or termination (e.g. where the breach of warranty is fundamental or if the seller is unable to transfer title to an essential asset of the business).

What is an indemnity?

An indemnity is a promise by one party to protect another party from, or to reimburse that party for, loss or damage suffered, or any expense incurred on the occurrence of a specified event.  The event may, but need not, include a breach of contract or some other legal duty by the indemnifying party.  For example, an indemnity may require a party to compensate another party on the happening of an external event such as a fall in the exchange rate.

Key similarities and differences between warranties and indemnities

The quantum recoverable for breach of a warranty is governed by ordinary contractual principles, meaning that the quantification of damages is subject to the principles of mitigation and remoteness. With an indemnity, it is the terms of the indemnity that govern what may be recovered.  This means that it is possible to recover a greater amount under an indemnity compared with a warranty claim if the indemnity so permits.

Both indemnities and warranties can be limited by the inclusion of contractual restrictions such as a threshold before claims are payable or a time limit in which to bring any claims.  In the case of indemnities, consideration should be given to expressly providing that the contractual principles relevant to remoteness of damage and mitigation will apply to limit the amount covered by the indemnity.

Warranties will be construed by the courts applying ordinary principles of construction, that is, by ascertaining what a reasonable person would understand by the language in which the parties have expressed their agreement.

Indemnities are strictly construed. This means that where it is possible any doubt as to the construction of an indemnity will be resolved in favour of the indemnifier.