The Most Common Warranty Claims After a Business Sale

Warranty claims are a common source of dispute after a business sale, and they often surface within the first 12 to 24 months after completion, when the buyer discovers a tax exposure, an undisclosed liability, or a problem with the target company’s contracts, employees or intellectual property.

This article explains which warranty claims arise most often under a share purchase agreement in England and Wales, how notification clauses and contractual time limits operate, and what a buyer can realistically expect to recover. It is written for buyers who suspect they have a claim and for sellers who have received, or fear receiving, a notice of claim.

Why warranty claims are so common after a business sale

Every business sale involves an imbalance of information. The seller has run the company and generally knows more about historic tax positions, operational practices, contracts, staff arrangements and latent disputes than the buyer can establish through due diligence alone. The buyer, however thorough its review, is usually working from a curated data room over a compressed timetable and cannot verify everything independently.

Warranties exist to help bridge that gap. They are contractual statements of fact about the target company, commonly given in the share purchase agreement, covering matters such as the accounts, tax, employees, contracts, property, litigation and intellectual property. They perform two main functions: they flush out information because a seller who cannot give a warranty cleanly should disclose the underlying issue, and they allocate risk because, if a warranty proves untrue and loss is caused, the seller may be liable subject to the contractual limitations in the SPA.

Claims often emerge in a predictable window. The buyer takes over management, prepares its first post-completion accounts, receives an unexpected HMRC query or complaint, and realises that the business acquired is not quite the business described in the sale process. That is usually the point at which the SPA, disclosure letter and any tax deed are scrutinised in detail.

Warranties, indemnities and the tax covenant: knowing what you are relying on

Before looking at the categories of claim, it helps to distinguish the three main protections commonly found in a share sale agreement, because the route relied on will shape what must be proved and what can be recovered.

• Warranties. A warranty is a contractual statement of fact. A claim for breach of warranty is therefore a contractual damages claim. Broadly, the buyer must show that the warranty was untrue, that loss was caused, and that the loss is recoverable under the SPA and the general law. In a share sale, the starting point for measuring loss is usually the difference between the value of the shares as warranted and their actual value at completion, although the precise measure depends on the drafting and facts of the case.
• Indemnities. An indemnity is a promise to reimburse or hold harmless in respect of a specified liability, such as a known dispute or an identified tax issue. The drafting matters greatly, but an indemnity often enables recovery on a pound-for-pound basis without the buyer having to prove diminution in share value in the way required for a standard warranty damages claim.
• The tax covenant. Most SPAs include a separate tax covenant or tax deed under which the seller agrees to pay an amount equal to certain pre-completion tax liabilities of the target that were not provided for, or otherwise fall within the agreed tax risk allocation. It usually sits alongside the tax warranties and has its own claim machinery and time limits.

The same facts may sometimes support a claim for breach of warranty, a claim under the tax covenant and, in some cases, a misrepresentation claim. Which route is strongest depends entirely on the wording of the SPA, the disclosures given and the surrounding facts.

Tax warranties and undisclosed tax liabilities

Tax is one of the most common sources of post-completion claims because liabilities may crystallise long after the underlying events and because HMRC can enquire into earlier accounting periods. The recurring themes include PAYE and National Insurance issues where individuals were treated as self-employed contractors, VAT that was under-declared or wrongly recovered, research and development tax relief claims that do not withstand scrutiny, and employee share scheme compliance failures.

Enterprise Management Incentive options are a particular trap. A defect in the grant process, the grant of options over shares that do not meet the statutory requirements, or a failure to notify HMRC within the applicable timeframe can jeopardise the intended tax treatment and leave the company facing unexpected liabilities or compliance problems. Because these issues often concern pre-completion periods, they are commonly pursued under the tax covenant if the drafting permits, rather than only by way of tax warranty claim.

Tax claims also usually enjoy a longer contractual notification period than general commercial warranty claims, but the exact period is always a matter of negotiation and drafting. Four to seven years is common, but not universal, and the agreement must always be checked rather than assumed.

Accounts warranties and hidden liabilities on the balance sheet

Buyers often price a target by reference to its historic accounts, so accounts warranties are central to many disputes. Typical warranties state that the accounts give a true and fair view, have been prepared in accordance with the relevant accounting framework, and make proper provision or disclosure for liabilities.

Claims arise where liabilities were omitted or understated, stock or work in progress was overvalued, bad debts were inadequately provided for, or revenue was recognised too early. Management accounts warranties are often more qualified than audited accounts warranties, sometimes referring only to preparation with due care and attention or consistency with prior practice, and that difference can materially affect the viability of a claim.

A related issue is causation and double recovery. If the relevant matter has already fed into a completion accounts adjustment, locked-box leakage claim, or purchase price reduction mechanism, the buyer may be prevented by the SPA from recovering the same loss twice.

Employment warranties, employment status and unpaid entitlements

Employment warranties generate frequent claims because employment liabilities can be systemic and multiply quickly across a workforce. Common problems include misclassification of staff as self-employed contractors, underpaid holiday pay, unpaid bonuses or commission, non-compliance with National Minimum Wage rules, pension auto-enrolment issues, and undisclosed grievances or threatened Employment Tribunal claims.

A recurring further issue is that consultants or contractors who created software, branding or other intellectual property may never have assigned those rights to the company under a valid written agreement. That point can give rise to both employment-related and intellectual property-related claims, particularly in founder-led or fast-growth businesses.

Because employment liabilities often overlap with tax liabilities, a single status issue can trigger several routes of claim at once. Care is therefore needed to analyse the claim structure properly and to avoid both under-claiming and impermissible double recovery.

Intellectual property, software and data protection warranties

For technology, media and service businesses, intellectual property warranties are often commercially critical because much of the value lies in software, brands, data or know-how. One of the classic defects is broken title: founders may have developed code before incorporation, contractors may have been engaged on informal terms, or agencies may have retained ownership under their standard terms.

Other recurring issues include open-source software used in a way that is inconsistent with the company’s intended licensing model, infringement of third-party rights, licences that are non-transferable or terminable on a change of control, and domain names registered in the personal name of a founder or former employee.

Data protection warranties are also increasingly important. Buyers commonly seek assurances that the target complies with the UK GDPR and the Data Protection Act 2018, has not suffered undisclosed personal data breaches, and is not subject to material investigation or enforcement action by the Information Commissioner’s Office. If those statements prove untrue, the buyer may face remediation cost, regulatory exposure and reputational damage.

Other warranty claims that regularly arise

Beyond the major categories, several other claims arise repeatedly in practice.

• Material contracts and change of control. Buyers sometimes discover that a key customer or supplier contract contained a change of control termination right, required consent that was never obtained, or had already been terminated or placed at risk before completion.
• Litigation and threatened disputes. Warranties that no litigation, arbitration or regulatory investigation is pending or threatened are often tested after completion, particularly where complaints, pre-action correspondence or regulatory enquiries existed but were not disclosed.
• Property, leases and dilapidations. Claims may arise where premises were occupied without proper consent, assignments or underlettings breached lease terms, break rights had been lost, or dilapidations exposure had not been identified.
• Share capital and corporate records. Historic allotment defects, undocumented options, unregistered transfers, or unlawful distributions can all generate significant claims and, in serious cases, raise title or governance issues.
• Regulatory permissions and licences. In regulated sectors, businesses may have breached licence conditions, allowed permissions to lapse, or carried on activities outside the scope of their authorisations.

How the disclosure letter can defeat a claim before it starts

Warranties are usually qualified by a disclosure letter. If a matter is fairly disclosed against the relevant warranty in accordance with the SPA, the buyer will usually be prevented from bringing a warranty claim in respect of that disclosed matter.

Disclosure is therefore a primary battleground in many post-completion disputes. The seller may say that the issue was disclosed expressly in the disclosure letter, in an attached bundle, or by reference to the data room; the buyer may respond that the disclosure was too general, too opaque, or insufficiently specific to amount to fair disclosure. Whether disclosure is effective depends on the wording of the SPA and the quality of what was actually disclosed.

Particular caution is needed with purported general disclosure of the whole data room. Seller-friendly drafting sometimes seeks to deem everything in a data room disclosed, but buyers often resist that position or qualify it by requiring disclosure to be sufficiently clear and specific.

Notification clauses and time limits: where many warranty claims fail

Many warranty claims fail on process rather than on merits. SPAs commonly require the buyer to notify claims in writing within a specified period and to include prescribed information, such as the nature of the claim, the warranties said to be breached, and, sometimes, an estimate of the amount claimed.

The courts may approach these clauses strictly where the drafting makes compliance a condition of liability. A notice that is late, sent to the wrong address, or lacking the level of detail required by the contract can therefore be ineffective even where there has been a real breach and real loss.

The broad market pattern is familiar but never universal. General commercial warranties often expire after 12 to 24 months; tax warranties and tax covenant claims often run longer, commonly four to seven years; and title warranties may be subject to a longer period or no contractual time limit at all. The operative question is always what the SPA actually says.

Separately, the Limitation Act 1980 may impose a statutory longstop, but that too depends on the form of the contract and the cause of action. For a simple contract, the basic limitation period is generally six years from breach, and a warranty in an SPA is usually breached, if at all, at completion. Many SPAs also require proceedings to be issued within a specified period after the notice of claim, often six or twelve months, failing which the claim is deemed withdrawn or barred.

What a buyer can realistically recover

Damages for breach of warranty are usually assessed by reference to the difference between the value of the shares as warranted and their actual value at completion. That often means the recoverable amount is not simply the face value of the underlying liability and not automatically the cost of fixing the problem.

In some cases, especially where the acquisition was priced by reference to EBITDA or another earnings multiple, the buyer may argue that the financial effect of the breach should be valued on a multiple basis. Whether that argument succeeds depends on evidence, valuation methodology and the facts of the transaction; it is not automatic.

Recovery is then commonly reduced further by the contractual limitations in the SPA. Those may include de minimis thresholds, basket provisions, liability caps, exclusions for certain heads of loss, anti-double-recovery wording, and restrictions preventing the buyer from recovering where the matter was allowed for in the accounts, specifically disclosed, or otherwise compensated through another contractual mechanism.

Where the money actually comes from

Establishing breach is only commercially worthwhile if there is a route to payment. In some deals, part of the price is held in escrow or retention, or deferred consideration is capable of set-off against claims. In others, there may be warranty and indemnity insurance, in which case the SPA and the policy both need to be considered closely because the policy may contain separate exclusions, retentions and notification requirements.

Where there is no fund, retention or insurance route, the buyer may need to pursue the sellers directly. That brings practical questions of solvency, asset location, enforcement and any contribution arrangements between multiple sellers into sharp focus.

If you are the seller and a claim letter arrives

Receiving a claim notice after completion is often unsettling, but the right response is usually a careful contractual and factual review rather than an immediate substantive concession. The first step is to test the validity of the notice against the SPA requirements, then to review the disclosure letter, data room materials and any relevant correspondence to see what was disclosed and how clearly.

The seller should then examine the SPA limitations, including time bars, thresholds, caps, exclusions and anti-double-recovery wording, and should require the buyer to articulate both breach and loss properly. A buyer that can identify a factual issue but cannot show recoverable loss measured in accordance with the SPA may still face a substantial obstacle.

Sellers should also check contribution arrangements between multiple warrantors and any available insurance cover. Care is particularly needed where allegations of misrepresentation or dishonesty are raised, because those claims may engage different legal considerations and contractual exclusion clauses may not provide the protection the seller expects.

How the Jonathan Lea Network can help

The Jonathan Lea Network acts for both buyers and sellers in post-completion disputes arising from share and business sales. These disputes are often won or lost on the interaction between the SPA drafting, the disclosure process and the evidence that emerges after completion.

Typically, the work involves reviewing the SPA, disclosure letter, tax deed and relevant due diligence materials, assessing the merits of the proposed claim or defence, advising on notice requirements and time limits, preparing or responding to a notice of claim, and supporting negotiation, mediation or litigation where needed. Many disputes settle commercially, often through escrow, deferred consideration adjustment or negotiated payment, but an early and well-evidenced analysis usually improves the prospects of a good outcome.

Contact Us

We will respond to most enquiries with both an indicative scope of work and fee estimate, as well as the offer of a complimentary 20-minute discovery video call to discuss your issues and how we can help, before sending a more considered formal fee estimate via email.

In some limited cases, if you would just like initial advice and guidance on a call, we may instead offer a fixed fee appointment (commonly charged between £280 to £500 + VAT) whereby we will review the information you provide, hold a video call consultation and then follow up with an advisory email (as well as a fee estimate for any further work identified).

Please email wewillhelp@jonathanlea.net or call us on 01444 708640 as a first step. We first need an overview of the background and your issues, together with any significant documents, to provide an indicative scope of work and fee estimate.

 

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This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited.