Warranties
Warranties are one of the most commonly sought protections. Warranties are statements of fact given by Target and/or the Founders (together, the "Warrantors") to the investor at exchange/completion. The warranties will typically cover information about the Target, its business and the accuracy of information provided to the investor (e.g. Target's business plan and share capital). If a warranty is untrue and the investor suffers a loss as a result, it may be able to claim damages from the Warrantors.
Methods of limiting liability
Warrantors can seek to limit their liability by:
- amending the warranties by making them subject to materiality or knowledge or by deleting particularly onerous ones;
- informing the investor of any circumstances which make any of the warranties untrue (a process known as 'disclosure');
- obtaining warranty and indemnity insurance; and
- including limitations of liability in the relevant documentation.
Key limitations of liability
Financial
The most common financial limitations are:
- Cap – this sets the maximum amount of damages the investor can claim. In relation to Target's liability, the cap will usually be an amount equal to the investor's investment plus any recovery costs. The Founders' liability would typically be capped at a multiple of their salary, though it is notable that the recently updated BVCA model documents no longer anticipate the Founders giving commercial warranties (akin to the US market). However, in our experience, investors still consider it important for the Founders to have 'skin-in-the-game' and provide commercial warranties.
- Disregard – if included this will usually be set at a few hundred pounds. Any claim under that amount will be disregarded. The idea is to prevent trivial claims and add an element of materiality. The investor may not agree to a disregard especially if it agrees to a 'threshold'.
- Threshold (or basket) – this would be set at a higher amount than a disregard (usually between 0.5% and 1% of the investor's investment). The Warrantors would not be liable for any damages until the investor has accumulated warranty claims with a value in excess of the threshold. Again, the intention is to introduce an element of materiality.
- The recently updated BVCA model documents do not include a 'disregard' or 'threshold'. The rationale for this was to seek to simplify the limitation provisions and avoid unnecessary negotiations – it is yet to be seen whether the market adopts this approach.
Time
A time limit for the investor to notify the Warrantors of any claims is usually agreed. This is typically between 18 months and two years (or in the case of any tax warranties, seven years due to HMRC's investigatory powers). The rationale is that any potential issues should come to light within this timeframe and it prevents the Warrantors having an open-ended liability.
Warrantors may also seek a requirement for the investor to commence proceedings within a few months of notifying a claim. This is to ensure any claims are dealt with as soon as possible.
Others
Other commonly agreed limitations include:
- requiring the investor to make claims against third parties in respect of the matter giving rise to the breach (if it has such claims); and
- excluding liability where a breach has arisen due to a post-completion change in law, taxation or accounting policies.
Limitations may not always apply
It is common for limitations to fall away if a breach results from the fraud, dishonesty or wilful concealment of the Warrantors. The Warrantors may argue that this should only apply to those Warrantor(s) guilty of those acts but the investor may reject this on the grounds that the Warrantors should take collective responsibility.
The investor may also insist that some or all of the limitations do not apply to claims under specific warranties (e.g. warranties relating to Target's share capital) because those warranties are so fundamental to its understanding of Target and its investment.
DWF has a market leading venture and growth capital practice in the UK, supporting investors and companies across several sectors including financial services, technology, media and telecommunications, life sciences and healthcare and real estate and infrastructure. If you have queries on any of the issues covered in this article please contact one of our experts: Dhruv Chhatralia BEM, James Bryce, Caroline Colliston (as the tax representative for the corporate articles), Darren Ormsby, Gemma Gallagher, Gary MacDonald, Paul Pignatelli, Scott Kennedy, Will Munday, Alex Stoughton, Francesca Kinsella, Graham Tait and Rosie Spencer.
