News | Understanding a Buyer’s Legal Protection Processes
In last month’s article I explained that as part of the
Pre-Sale Process,
the seller will generally want to provide limited information -
presented in a format which is largely intended merely to whet the
appetite of a prospective purchaser. As the sales process progresses,
what legal protection will the buyer endeavour to obtain?
A well advised seller, as part of the legal process involved in a
sale and purchase, will generally be successful in seeking not to be
legally bound by most pre-sale statements regarding the business that
might have been made to the prospective buyer.
Accordingly, while there remain transactions in which effectively a
buyer merely hands over its offered purchase price and ‘hopes for the
best’, because a seller will generally wish to elicit an offer from the
buyer of as high a price as possible for the business being sold, it is
generally the case that the seller agrees to give some element of
comfort to the buyer as to the full worth of the business which the
buyer proposes to purchase.
Two main legal processes have evolved - with the aim of giving the
buyer comfort as to the worth of the business they are buying, and
thereby allowing the buyer to offer more for the business than would be
the case in a situation when the buyer is required to bear an element of
risk as to the worth of the business it is buying.
The desired result should be to allow the respective parties to
legally agree the ‘best deal’ that can be realistically achieved between
them.
The Due Diligence Process
The first of these legal processes is known as ‘due diligence’.
This process broadly involves the buyer (prior to entering into a
legally binding agreement) asking the seller a range of questions in
relation to the prospective business which is proposed to be bought,
followed by the seller both answering those questions (as fully and
accurately as it can), and the seller producing supporting documentation
(and any other evidence) to support the answers given to the questions
asked.
The buyer will need to carefully consider the answers given and
documentation (and other evidence) produced – so as to ensure that there
are no perceived issues for the buyer with the business proposed to be
bought – at the price proposed to be paid.
The Warranty and Indemnity Protection Process
The subsequent (although accompanying) process is known as ‘warranty and indemnity protection’.
Warranties and indemnities are a set of contractual statements and
promises in relation to the business being bought, which the buyer asks
the seller to make as part of the legal agreements.
At their simplest, warranties may effectively be a statement by the
seller that they have fully and
accurately answered, and provided all
documentation (and any other evidence) in response to the due diligence
process.
Generally a buyer will ask for warranty protection in as
all-encompassing a format as possible, and the seller will seek to
qualify the requested warranty protections by way of a ‘disclosure
letter’ - which seeks to set out the pertinent factual position – with
the result that the buyer becomes fixed with knowledge of that factual
position and loses their right to potential compensation in relation to
matters which are disclosed to it.
Indemnities are a slightly different mechanism, by which (generally) a
seller agrees to specifically compensate a buyer (usually) against the
risk of a particular valuation issue occurring (e.g. a potential
liability of the business actually arising in practise).
The Aims and Effects of Due Diligence and Warranty and Indemnity Protection
For the buyer, the process of undertaking due diligence and obtaining
warranty and indemnity protection, allows it to gain some comfort and
protection as to the worth of the business which it is proposing to
acquire.
This in turn allows it to consider paying a full price for the
assets, comfortable in the knowledge that it has reduced a certain
element of the risk involved in the transaction.
The interested parties should be made aware (in early course) that it
is highly likely that the due diligence process and the warranty and
indemnity protection process will require them to devote considerable
time and effort to achieving the desired outcome of achieving a maximum
purchase price (for the seller) - and appropriate comfort and protection
for the buyer, as to the business that they are buying.
Because Evolution Capital's aim is to ensure that the legal process
is an integral part of the overall sale process – this should have the
effect of ensuring a smooth progression of these legal processes as part
of the overall transaction – and thereby efficiently and economically
progress the interested parties from agreement in principle upon a
transaction through to completion
Occasionally these legal processes bring to light (prior to a legal
agreement being reached) a situation that is an issue for the buyer (and
– in many cases – that the seller was not envisaging would be an issue
for the buyer).
These legal processes allow buyer and seller to discuss the relevant
problematic issue prior to entering into any legal agreement, and
thereby to seek to resolve the issue by a number of possible approaches
which can be taken (e.g. fuller explanation of a perceived issue by the
seller to the buyer removing any concerns, adjustment to the sale and
purchase price and / or a contractual agreement adjusting which party
bears a risk of a potential liability crystallising – i.e. an indemnity
etc.). The hoped for end result is a much fairer and more reasonable
‘deal’ with the ‘right’ sale and purchase price being agreed to be paid
for a ‘correctly perceived’ business.
If notwithstanding these processes, the business which is transferred
is not that which was indicated as part of the due diligence process,
and as such position is contractually supported by the warranties and
indemnities, then the buyer will generally have a potential contractual
recourse against the seller for compensation pursuant to the terms of
the sale and purchase agreement.
The warranties and indemnities in such circumstances can accordingly
be considered to be a means to adjust the purchase price to the ‘right’
sale and purchase price which would have been paid, if the purchaser had
been able to accurately understand the situation of the business that
they were acquiring.
It is so as to hopefully avoid the necessity for such ‘post deal
price adjustment discussions’ that the interested parties (and their advisers) should focus upon these legal processes as an absolutely
crucial part of successfully achieving the completion of the
transaction.
