A share sale agreement usually sets out detailed representations and warranties given by the seller when the documents are signed. The seller confirms the company’s position as at the sale date and gives further assurances regarding the subject of the transaction. Accurately defining the target’s position determines its subsequent valuation and the profitability of the transaction as a whole. The parties should therefore agree how the seller will be liable for the accuracy of those representations and warranties.
Ways to define the seller's liability
The parties can choose, among others, the following clauses: (1) de minimis (materiality threshold), (2) basket, and (3) liability cap. Each provision regulates the buyer's ability to pursue claims and the amount of damages available in a different way.
A de minimis mechanism sets a minimum damages amount below which the seller does not recognise the buyer's claims.
A basket clause requires the aggregate value of all individual claims to exceed a specified threshold before the buyer may pursue a claim for breach of representations and warranties. There are two forms: (i) first dollar, under which the full aggregate amount can be claimed, and (ii) excess only, under which the buyer may claim only the amount above the agreed threshold.
A liability cap works in the opposite direction: it limits the seller's liability by setting an upper monetary ceiling, usually expressed as a percentage of the sale price.
Remember to secure your claims properly
When drafting the sale agreement, remember to secure the ability to enforce claims arising from the representations and warranties. This can be difficult if the share price is paid directly to another entity, the ultimate financial owner, or if there is a risk that the seller will be liquidated.
Similar problems may arise with ownership structures restricting recovery from shareholders or management board members, or where a foreign entity's operation and liability are governed by foreign law.
Depending on the identified risks, various mechanisms can secure the buyer's future claims under representations and warranties, including provisions prohibiting the seller's liquidation, retaining part of the price or obtaining third-party sureties and guarantees, including from the ultimate financial owner.
Could insurance be worth considering?
Another solution is to purchase representations and warranties insurance, frequently offered in Western markets but still relatively uncommon in Poland’s M&A market. Either the seller or the buyer can obtain it. This form of protection for future claims is particularly attractive because it can extend the duration of representations and warranties and avoid tying up the seller’s funds. The seller therefore receives the full price on completion, which in turn improves the buyer’s negotiating position.
W&I insurance terms depend on the transaction, due diligence findings, coverage limit, exclusions and deductible. When comparing offers, establish the base to which the premium relates. Transaction value and liability limit are not interchangeable bases for calculating a percentage.
