Liability provisions are a key part of any share sale or investment transaction. They determine how much financial risk a seller, founder or company retains after completion and are often among the most heavily negotiated provisions in the transaction documents.
Buyers and investors naturally want broad protection if something goes wrong. Sellers, founders and companies, however, need to ensure that their exposure does not leave them facing significant claims after the transaction closes.
Share Sales
Without contractual limitations, a seller can remain exposed to contractual claims for a significant period following completion. Such limitations will be contained within a share purchase agreement (SPA).
Financial caps
The seller's liability for business warranties will usually be subject to an agreed financial cap. The level will depend on the transaction but is often equal to the sum received by the seller in respect of the purchase price for their shares.
Fundamental warranties, such as title to the shares and the seller's capacity to sell them, will generally have a higher, often unlimited, cap, because they relate to matters which are so prudent to the acquisition that they ought not to be subject to any financial limitation.
Time limits
General warranty claims are commonly subject to a relatively short period, often 12 to 24 months after completion. Tax claims will usually remain open for longer - typically up to 7 years in keeping with HMRC standards. In each case, these limits provide sellers with greater certainty and prevent claims being brought indefinitely after completion.
Thresholds
A de minimis threshold prevents claims below an agreed amount from being brought in relation to a breach of warranty. A basket then requires qualifying claims to exceed an aggregate threshold before the buyer can recover. These provisions avoid sellers being exposed to numerous small claims and ensure that only material issues result in a financial claim.
Disclosure
The disclosure process is one of the seller's most important protections. Matters that have been properly disclosed against the warranties should not generally give rise to a warranty claim by the Buye. The parties should agree what constitutes sufficient disclosure and a detailed specific disclosure will generally provide greater protection than a general reference to, for example, Companies House filings or the Company’s accounts.
Warranties may also be qualified by the seller's knowledge, particularly where the seller cannot reasonably be expected to know every detail of the target company's business.
For a more detailed analysis on this area, please look at our article on Disclosure Letters here.
Other protections
An SPA will commonly include provisions dealing with:
- when and how claims must be notified;
- procedures for dealing with third-party claims;
- exclusions for certain types of loss;
- preventing double recovery;
- reducing claims where the buyer has already recovered the relevant loss elsewhere; and
- requiring the buyer to mitigate its losses.
Together, these provisions are intended to ensure that the buyer can recover genuine losses without receiving more than it has lost.
Fraud, indemnities and W&I insurance
No contractual limitation can protect a party from liability for its own fraud. Fraud and deliberate wrongdoing should therefore be carefully carved out from the liability protections.
Known risks identified during due diligence may instead be dealt with through specific indemnities. These can provide the buyer with more direct protection than a warranty and will usually have their own caps, exclusions and time limits.
Warranty and indemnity (W&I) insurance can also transfer some or all warranty risk from the seller to an insurer. This can be particularly attractive where a seller wants a clean exit, but the buyer still requires extensive contractual protection.
Investment Rounds: Protecting Founders and the Company
Investment transactions present a different risk profile. Founders generally remain involved in running and growing the business after the investment, so their personal liability needs particular consideration.
The company will typically provide warranties to the incoming investor, but investors may also seek personal warranties from the founders, although this is increasingly a matter for negotiation.
The model documents published by UK Private Capital (formerly the British Venture Capital Association), the official industry body and public policy advocate for the private equity, venture capital, and private credit ecosystem in the United Kingdom, provide an important market benchmark and generally take a more founder-friendly approach by placing the primary warranty burden on the company.
Warranties given by either (or both) the Company and the Founders should seek a clear financial cap, appropriate knowledge and materiality qualifications, sensible time limits and other key limitations akin to that in a share sale, and as described in this article.
Financial limitations on warranties on an investment transaction tend to differ slightly, however. A cap by the Company linked to the investment received is common and helps prevent the investment itself from becoming an effectively unlimited source of recovery for the investor. Where founders give warranties, mark practice is typically for founders’ financial liability to be capped at an amount equal to their annual remuneration.
As with a share sale, a properly conducted disclosure process is critical. It gives investors visibility of known issues while protecting the company and founders from claims relating to matters that have been properly disclosed.
The role of Culbert Ellis
At Culbert Ellis, our corporate team regularly advises sellers, founders and companies in different sectors on the allocation of liability in share sales and investment rounds, including the drafting and negotiation of warranties, disclosure letters, indemnities and liability limitations. We work with clients to ensure that these provisions provide appropriate protection while remaining proportionate to the transaction and aligned with the wider commercial objectives of the parties.
How to get in contact
To find out more or if you require assistance with these matters, speak with our Corporate Transactions and Investments Team on +44 (0)204 600 9907 or email info@culbertellis.com.
Accurate at the time of writing. This information is provided for general information purposes only and should not be relied upon as legal advice.
