Understanding Warranties in Mergers and Acquisitions Transactions

Whether you are the buyer or seller in a merger & acquisition (M&A) deal, warranties play a vital role, and entire transactions can hinge on their scope and accuracy.

Warranties are essentially legal promises – guarantees given by the seller to the buyer about key business elements. Whilst they are unsurprisingly an indispensable requirement for the buyer, the disclosure of warranties serves an important function in allocating risk between parties. This guide will explore the nature of warranties in mergers and acquisitions, common types of warranties and their potential limitations, and the importance of proper drafting to protect the interests of both parties to the transaction.

What Are Warranties in Merger and Acquisition Transactions?

Warranties are legally binding, contractual statements of fact, given to the buyer about the finances, condition, operations and affairs of the business being sold (the target business). These assurances are designed to ensure transparency in the deal and give the buyer a clear understanding of what they are purchasing. If a warranty is found to be untrue or misleading, the buyer has legal rights under contract law to claim compensation.

Why Are Warranties Necessary?

If you are the buyer, the importance of warranties is clear. Buying a target company without a legally enforceable promise from the seller about its actual operations is dangerous and downright silly. But warranties serve multiple purposes in corporate restructuring and acquisition transactions, and can provide protection for the seller as well.

Risk Allocation: By providing warranties, the seller assumes responsibility for specific elements of the business. They represent to the buyer that the content of the warranties is true and therefore assume the risk in the event they are breached. Without them, the buyer would be on the hook for everything, so they provide essential assurances against unknown liabilities. Likewise, for the seller, the warranties provide a clear scope of their obligations under the deal.

Due Diligence: Before entering the transaction, both parties must complete thorough due diligence. The seller wants to ensure the buyer is ready and able to purchase, while the buyer wants to confirm that the target is as it appears. Warranties, therefore, provide a crucial complement to due diligence. Buyers rely on warranties to confirm the accuracy of information uncovered during this process, as well as to “fill in the gaps” of what might be missing or could not be ascertained throughout the due diligence process.

Transparency and Disclosure: Because of the way warranties operate, the seller is motivated and, in many respects, required to communicate known issues and relevant factors to the buyer to avoid potential responsibility for breaches down the line. Therefore they also promote full and frank disclosure of all material elements.

Common Seller Warranties in Mergers and Acquisitions 

The specific warranties that are included or excluded in a merger or acquisition will naturally vary depending on the nature and size of the target business, bargaining power of the parties and the transaction itself, but there are some common provisions found across most transactions.

Title and Authority

Title warranties are crucial in mergers & acquisitions as they confirm that the seller possesses the legal and beneficial interest in the shares or assets being transferred. These warranties ensure they have the right to sell the business without any third-party claims or interests over the shares or their assets, thereby safeguarding the buyer’s interests and providing clarity and security in the transaction.

When saying that the seller has the authority to enter into a transaction, this means that there are no legal or regulatory issues preventing the sale. For example, the seller usually warrants that it has obtained requisite consent from shareholders, the sale is in accordance with the company’s constitution, and there are no relevant laws which may prohibit the business being sold.

These are fundamental warranties, because if they are breached, the entire transaction may be jeopardised.

Solvency, Finances and Accounts

In most cases, a seller is expected to warrant that the business being sold is solvent at the time of the sale—that is, it is able to pay its debts as they fall due and its liabilities do not exceed its assets (and that there is no outside controller appointed, such as administrator, liquidator, or receiver). These warranties are critical because they protect the buyer from inheriting a business that is financially distressed or on the verge of insolvency, which could significantly undermine the value of the acquisition and expose the buyer to unexpected issues.

The seller is usually required to provide its last set of annual accounts (audited, if available), as well as the management accounts for a few months leading up to completion, in order to give an accurate overview of the business’ working capital. Accounts warranties assure the buyer that the seller has prepared all relevant accounts in accordance with accounting standards, and any applicable laws, and that the accounts give a fair, accurate and reasonable view of the actual financial position of the business being acquired (including divulging all liabilities).

Assets

In corporate transactions, buyers typically require warranties confirming that the target business owns or validly uses all assets necessary to operate its business. This includes assurances of good and marketable title, that assets are in good working order, and free from undisclosed third-party interests. Buyers also seek confirmation that the assets are sufficient to continue running the business as currently conducted. These cover both tangible assets—like equipment, inventory, vehicles, and property—and intangible assets such as IP, licences, domain names, and goodwill. Depending on the business, additional warranties may address specific asset types like data, tech infrastructure, or customer databases.

Contracts

Contract warranties typically require disclosure of all material contracts to which the target company is a party and to warrant that those contracts are valid, binding, in full force and effect, and not in default. The buyer relies on these warranties to assess the commercial obligations and revenue streams of the business, as well as any concerns of termination, breach, or liability. They may cover customer and supplier agreements, leases, distribution arrangements, and joint ventures, and often exclude contracts that are immaterial in value or strategic importance. A breach of this warranty could expose the seller to claims if, for example, a key contract had been terminated, was non-transferable, or contained a change of control clause that had not been flagged.

External Debts

These relate to the financial obligations of the target company, such as loans, credit facilities, promissory notes, and other forms of borrowing or third-party debt. These warranties usually require the seller to confirm that all such debts are accurately divulged, that the target is in compliance with the terms of its financing arrangements, and that there are no undisclosed guarantees, security interests, or defaults. Buyers rely on these warranties to understand the financial exposure of the business and to ensure there are no surprise obligations that could affect valuation or post-completion operations.

Litigation and Disputes

The seller usually warrants that the business is not party to any litigation or legal proceedings, formal dispute resolution processes (such as mediation and arbitration), disputes with former employees, or any governmental, police or other investigations.

Compliance

These warranties confirm that the business complies with all relevant laws and regulations of the relevant jurisdiction in which it operates, as well as in accordance with any special laws or rules relating to the industry of that business or any licences and authorisations the business is subject to. These include, but are not limited to, employment, health and safety, environmental protection, disclosure to reporting bodies, tax, counterterrorism and anti-money laundering. Non-compliance may lead to regulatory fines or legal actions against the buyer down the line, so it is essential that the warranties protect their interests in this regard.

Key Warranty Limitations in Merger & Acquisition Agreements

Warranties will be drafted with certain qualifications or limitations in place to reasonably protect the seller’s position. These will be considered below:

Time Limitations

Warranties typically include a set timeframe during which the buyer can bring a claim for a breach. General warranties (such as those relating to employees and assets) usually survive for 12-24 months post-completion of the transaction under most circumstances. Some warranties will last much longer. For instance, if any are given in relation to the tax status of the business, these will typically last 5-7 years (in line with standard periods under taxation laws).

Sometimes, certain liabilities may be indefinite. These can be for fundamental warranties, such as title and authority as described above.

Where a time limitation exists, the buyer will be unable to bring a claim once the relevant warranty period expires.

Liability Cap

A liability cap limits the vendor’s maximum exposure for breach of warranties, giving them certainty over the extent of their exposure post-completion. It is usually expressed as a percentage of the purchase price—commonly 50% to 100%, depending on the type (with a lower cap for general warranties and a higher or even uncapped liability for fundamental warranties such as title, ownership of shares, or capacity). The cap does not typically apply to claims that result from fraud or wilful misconduct, which are often excluded from all limitations.

Liability Minimums (Also known as “De Minimis” and “Basket”)

To avoid the disclosing party being exposed to minor or trivial warranty claims, agreements often include minimum thresholds before liability arises—commonly referred to as de minimis and basket provisions. The de minimis sets a threshold for individual claims, meaning no single claim below this value can be brought. The basket (also called an aggregate threshold) sets a cumulative minimum—where the discloser is not liable for warranty breaches until total claims exceed a set amount, usually a percentage of the purchase price.

Baskets can be structured as “tipping” (once the threshold is exceeded, the seller is liable for the full amount of all claims) or “deductible” (the seller is liable only for the excess over the basket threshold). These provisions are intended to strike a balance between protecting the buyer from material losses and shielding the selling party from nuisance-level claims.

Materiality Qualifications

A common qualification on warranties in transaction documents is materiality, which limits the liability of the seller only to those that reach the threshold of material or significant breaches.

For instance, the seller may include a warranty to the effect of: “There are no material claims pending against the Company.” Inclusion of the word “material” protects the seller against claims brought by the buyer for minuscule or insignificant financial claims. Of course, the buyer will naturally seek to have such wording struck out – so both parties should expect much negotiation on this issue. The exact threshold of what constitutes “material” is also a subject of debate, and sometimes parties will insert a specific threshold (e.g., $150,000) to achieve clarity.

Knowledge Qualifications

Another common qualification seen in warranties is that the seller will only be liable for breaches that it was actually aware of.

For example, A seller has given a warranty that no customers have raised a complaint with their products in the last two years. Unbeknownst to them, a customer has recently raised a complaint with their account manager. It just hasn’t filtered through to the business owner yet. If the warranty is not qualified by knowledge, then the seller will be liable for a breach. But if it is qualified by knowledge, the seller will not be liable.

Knowledge qualifications are more common for larger businesses where the sellers are no longer in a position to know every little detail of the company. They are also more common for more minor or operational matters as opposed to the fundamental warranties (such as title and authority warranties, warranties about external debt or accounting etc).

For instance, it would not make sense to qualify a warranty that the seller owns its shares in the business – the buyer will expect absolute clarity on this issue, without any qualification.

Disclosure

Crucially, the seller can limit their liability under the warranties by disclosing all known exceptions to the warranties. Disclosure is affected formally – usually through a specific disclosure letter with references to which warranties a disclosure relates to, and sometimes with more general disclosures (which may include the entire contents of the virtual data room used during buyer examination, as well as public registers).

Contracts often require a matter to be “Fairly Disclosed” in order to actually exempt the seller from responsibility. “Fairly disclosed” generally means that a matter has been clearly and adequately communicated to the buyer in a way that allows them to understand the nature and scope of the issue. This forces the seller to make a proper disclosure, as opposed to burying a vague reference to the issue in some remote corner of the data room.

The seller must prepare accurate and thorough disclosures, which the buyer must review with a keen eye to be aware of all relevant red flags associated with the business. The buyer must also understand that, once finalised, they cannot bring action for any issues notified to them in advance.

Warranties in M&A Key Takeaways

Warranties are an indispensable and highly negotiated aspect of the corporate acquisition process. They serve a dual purpose: providing a safety net for buyers and offering a structured risk allocation framework with potential limits through disclosure for sellers.

Given the complexity of these provisions, seeking legal advice from experienced merger and acquisition lawyers is crucial. They can assist in drafting warranties that accurately reflect the target company’s status, the transaction size, and align with commercial realities, thereby protecting your interests long after the deal closes.

Whether you are considering buying or selling a business, the team at UX Law are highly experienced and accredited for their diligence, thoroughness and commercial flexibility in M&A transactions. We have successfully navigated complex national and international transactions, acting for both buyer and seller, whether it is a single company or a large group, and have a wealth of experience in navigating the complex regulatory and legal provisions relating to warranties and disclosure. If you have any questions about mergers & acquisitions or need any advice on business matters, get in touch with our experienced lawyers.