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 as a result 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 in this context are promises by the seller as to the state of affairs of the business. If these promises are inaccurate and cause the buyer loss, the buyer may have remedies against the seller, in particular, 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.

Similarities and differences between warranties and indemnities

The quantum recoverable for breach of a warranty is governed by ordinary contractual principles, meaning that that 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 may be 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 or a cap.

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 or operation of an indemnity exists, it will be resolved in favour of the indemnifier.

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For more information, please contact Gavin McInnes on 07 3367 8681 or gmcinnes@grmlaw.com.au.

 The information contained in this article is general in nature and cannot be regarded as anything more than general comment. Readers of this article should not act on the basis of this comment without consulting one of GRM LAW 's legal practitioners who will consider their particular circumstances.

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