Post sale liabilities: strategies for a smoother exit

Paul Matthews, director and head of Corporate and Commercial Team, WHN Solicitors shares some advice for a smoother exit from business.

Paul Matthews has more than 30 years’ experience advising businesses across the North West on corporate transactions, including sales and acquisitions, management buyouts, company reorganisations, shareholder agreements, joint ventures and partnership law issues.

He said: "If you have never bought or disposed of a business, you could be forgiven for thinking that when the ink dries on the sale agreement, the seller doesn’t need to worry about any of the company’s future liabilities, costs or issues which could operations or financial wellbeing.

"However, with most deals, there is a wide range of situations in which a buyer may be able to claim against a seller following a sale. The extent of these liabilities is keenly negotiated during a transaction, and it is the job of the seller’s legal advisers to protect their client from and mitigate the risk of future liability as much as possible.

"There are three main types of post-sale liabilities: warranties, indemnities and tax covenants.

Warranties

"Warranties are contractual statements of fact made by the seller at the exchange of contracts and completion about all aspects of the company and its affairs, including its financial position, accounts, assets, contracts, employees, litigation, regulatory compliance and tax, designed to protect the buyer against unexpected liabilities.

"Where any of the statements are inaccurate, a disclosure letter from the seller will identify exceptions to warranties, with supporting documents. This allows a buyer to then proceed, decide against buying the company, negotiate a reduction in price or consider other steps to mitigate any identified risks. 

"A key task for a seller’s legal adviser is reviewing the warranties with the seller to ensure any exceptions are identified and disclosed in this letter. To the extent the exceptions are fully and fairly disclosed, the seller will have no liability for breach of warranty. In a share sale, failure to disclose breaches of warranty can also be a criminal offence.

"Despite this, circumstances which lead to a breach of warranty may come to light that the seller was unaware of. For example, if the company had sold goods that were not fit for purpose, the seller may be unaware unless the customer complained prior to completion. Therefore, a seller’s legal professional will often seek to qualify warranties by reference to the seller’s knowledge.

Indemnities

"An indemnity is a contractual promise by the seller to compensate a buyer for specific costs or liabilities resulting from specified events. For example, if the company is the subject of an ongoing investigation, the buyer may require an indemnity against any costs of dealing with that and any resulting financial penalty imposed.

"Requests for indemnities typically arise in two situations:

1. An issue identified in a disclosure letter as an exemption to warranty which the buyer cannot accept - and therefore seeks a specific indemnity for. For example, if the company is the subject of an ongoing data protection investigation, the buyer may require an indemnity against any related to that and resulting financial penalties
2. An issue identified during due diligence which has the potential to affect a company’s operations in future. For example, staff not having particulars of employment in place which could give rise to claims by employees.

Tax covenants

"The aim of a tax covenant is to protect the buyer’s tax liabilities which are unexpected (and have therefore not been considered in agreeing the price) resulting from events which occurred before completion. 

"This could include additional tax liabilities assessed on the company following a post-completion HMRC investigation which relate to the company’s activities at a time when the company was owned by the seller.

Obtaining legal support

"Instructing a legal professional at the earliest possible stage is key to minimising risks and liabilities in a business sale. 

"Regarding post-sale liabilities, early instruction gives a solicitor a greater opportunity to investigate risks and issues which could give rise to a breach of warranty. It may be that these can be addressed before completion but, if not, the legal professional’s role will be to ensure they are correctly disclosed to the buyer."

To speak with Paul on a corporate or commercial matter, contact him directly at [email protected].