Despite undertaking due diligence on the target, the buyer will still need to protect itself from the risks involved in acquiring shares or a business, since the law is one of caveat emptor (=the principle that the buyer alone is responsible for checking the quality and suitability of something before buying it). The buyer will seek express contractual protection in the form of warranties and indemnities given by the seller in the SPA. Where there is more than one seller, the buyer will want the sellers to give the warranties and indemnities on the basis that they are jointly and severally liable for any breaches.
The buyer may seek security for a breach of any warranty or indemnity by insisting that the seller’s parent company or a third party provide a guarantee in respect of the seller’s obligations. Another method is for the SPA to provide for the buyer to retain part of the purchase price of the target after the completion (or closing) of the transaction and for this amount to be used to pay any successful claims under the warranties and indemnities.
The seller will want to limit its potential exposure to liability under the warranties and indemnities. This will typically include the insertion of provisions in the SPA excluding de minimis claims, which means that the buyer cannot claim for breach unless the claim exceeds a certain amount, putting a maximum cap on its total liability, for example to the total consideration received by the seller under the SPA, and imposing a time limit during which claims can be made which is less than the statutory limitation period.
The seller will also usually provide a disclosure letter to the buyer under which the seller makes general and specific disclosures regarding the warranties contained in the SPA. This has the effect of qualifying the warranties so that the seller avoids being in breach of warranty in respect of those matters disclosed. The SPA will provide that the warranties are given subject to the matters disclosed in the disclosure letter.
In order to protect the value of the buyer’s investment, the buyer will want to restrict the post-completion activities of the seller. It is common, therefore, for the seller to give undertakings in the SPA (known as restrictive or non-compete covenants) not to compete with the target company, solicit existing customers, suppliers or employees of the target, and use or disclose confidential information about the target for a specified period within a specified area. In order for restrictive covenants to be enforceable by the buyer, they must be reasonable to protect the buyer’s legitimate business interests, namely the goodwill and business secrets of the target. In assessing what is reasonable, the duration, geographical area and overall scope of the restriction need to be considered.