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Oct 08, 2020

The Importance of Vendor Warranties

Contact: Mark Poretti

In most business sales, the humble vendor warranty is often overlooked and understated in its value to the purchaser. This is despite the significant consequences if a vendor breaches these warranties (e.g. termination of contract and damages).  In this article we review the importance of vendor warranties and how a tailored approach can provide a significant level of protection for the purchaser.

What is a Vendor Warranty?

Vendor warranties are promises provided by a vendor to the purchaser as part of a business sale agreement. Essentially, the vendor will be promising to the purchaser that a particular state of facts exists. Vendor warranties are important for the purchaser, as they provide certainty that the purchaser is getting what they paid for. This is particularly so, where the purchaser has not been able to conduct a thorough due diligence or the vendor does cannot make all of its financial information available.

Examples of common vendor warranties

The following are examples of vendor warranties that often appear in business sale agreements:

  1. all plant and equipment, machinery and fixtures of the business will be in good working order and condition;
  2. the books and finances of the business are up to date and accurate;
  3. the business and the business premises have all necessary government approvals or licences, and complies with all relevant legislation and/or regulations; and
  4. there are no outstanding orders or notices that may affect the business, or no known legal disputes or claims to which the business may be subject.

Why are warranties important

Warranties can provide certainty and protection for a purchaser.  A purchaser has several remedies available to them if a warranty is breached, including an action for breach of warranty and action under the Australian Consumer Law (ACL). Usually, an action for damages will rely on both causes of action, and the making of misleading and deceptive representations which is prohibited by s18 of the Australian Consumer Law (ACL), cannot be excluded by contract.

Additionally, a failure to disclose any significant facts or information may well be in itself misleading and deceptive conduct, even if due diligence has occurred. Silence on any material issue can give rise to a liability in damages, or allow a rescission of the contract particularly where there exists warranties assuring all material information has been disclosed.

A rather unusual example!

The High Court case Clark v Macourt [2013] HCA 56, highlights the importance of these warranties.

The Vendor was a fertility company which agreed to sell its business to the Purchaser for approximately $400,000.00. The assets of the business included frozen sperm samples. The Purchaser was told all the sperm samples were usable, and the contract included a warranty from the Vendor to this effect. The Purchaser later discovered less than half the samples were could be used. This meant the Vendor was in breach of its warranty.

The Purchaser needed to spend over $1.2 million to buy replacement samples. The High Court held the Purchaser was entitled to damages to compensate for the full $1.2 million loss. It did not matter this was a larger amount than the original purchase price.  Significantly, the Director of the Vendor was a guarantor in the contract and had agreed to personally guarantee the Vendor’s obligations. Because the Vendor was in liquidation, the Purchaser sued the Director and he was ordered to pay the damages personally (1.2million!).  This case illustrates the importance of properly constructed vendor warranties, without which, the purchaser would lose $1.2 million.

The importance of security

The above example also emphasises that despite the breadth of concerns warranties can cover, it is essential the warranties are coupled with a measure to secure any entitlements upon breach. Without some form of security, the purchaser may make a valid claim against a now-insolvent vendor, and have a warranty worth little more than the paper it is printed on.  A prudent purchaser can take the following actions to protect itself:

  1. retain part of the purchase price. This is kept in an independent account and is released to the vendor after a set period of time, minus anything due to the purchaser as damages for a breach of warranty;
  2. obtain a guarantee from a parent company or a personal guarantee from a director; and
  3. take a charge (caveat) over the vendor’s or guarantor’s assets.

To obtain tailored legal advice on your property matters, please contact Trinity Law on (02) 6163 5050 or email your query reception@trinitylaw.com.au

The information in this document represents general information, and should not be relied for your specific circumstances. If you require legal advice and assistance on the matters contained or associated in this document you should contact Trinity Law. Subject to the limits of the law, Trinity Law disclaims any liability on persons relying on this document.

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