Sale price isn’t the only money issue

June 1, 2002 By    

Inexperienced buyers and sellers of propane businesses often lose interest in the details of the transaction once they have signed the letter of intent or term sheet that outlines the broad terms of the deal. Even smart, successful businessmen fall into this practice because they don’t deal with the consternation of buying and selling businesses every day.

Yet several of the most hotly contested issues between buyers and sellers can have the same impact as lowering the sale price – after the fact!

At issue is the scope of indemnification by the seller for breaches of the representation and warranty to the buyer.

The primary purpose of the seller’s representations and warranties to the buyer is to have a written record of the business status as of the date of the agreement. Since the buyer has based the purchase price on that assessment, any inaccuracies can delay closing. The seller also may have to reimburse the buyer if a representation or warranty is proven incorrect after closing.

A simple example of a representation and warranty is that “the company has good title to all of its assets, free and clear of any liens or encumbrances” except for those matters listed in the agreement. If a lien is subsequently placed against the seller’s assets, a record is created to determine whether the lien was disclosed to the buyer for consideration in the purchase price. This “record” protects buyers and sellers.

The buyer will insist that the acquisition agreement requires that the seller reimburse him for losses and costs resulting from the inaccuracies. This reimbursement by the seller is called indemnification.

The issue is the limitation, if any, the seller is able to negotiate on the time period and amount of that indemnification.

If the purchase agreement does not specify, there will be no limits – including the full purchase price. The law imposes a limit on the time within which a claim by buyer against seller may be made, but sellers should not rely on them because they are usually many years in duration.

Normally, the seller maintains that the amount of indemnification should never exceed the purchase price because the seller’s total risk, without a sale of the business, is the total value of the business. Presumably, that value is the purchase price.

An experienced or well-advised seller will argue that if, as a result of the acquisition, he will remain at risk for the total loss of his business (or even more if the buyer will not agree to any limit). So why should he sell?

The buyer will likely counter that he has based the purchase price on the correctness of the seller’s representations and warranties, and that not even the purchase price is an appropriate limitation on indemnification because the business is subject to catastrophic, product liability losses. Obviously, product liability insurance comes into play.

Often, varying limits on indemnification by sellers are negotiated as to different types of representations and warranties. I have represented sellers who agree to the entire purchase price as a limit on title warranties, but something less on other types of claims.

The seller, seeking limitations as to the time that claims may be made by the buyer, argues that one of the main reasons for selling is to “get out from under” the risk of loss from the business being sold.

Likewise, certain types of losses often have limitations on when they may arise. For example, after three years, most losses from matters existing at closing will have surfaced. Yet the buyers maintain that they do not care when the loss arises if it constitutes a breach of the warranty made about the seller’s business.

Even if the existence of the matter causing the loss was unknown to all parties, it can be argued that the seller was in the best position to have known about the matter and the negotiated purchase price assumed no such loss.

There are many, many other issues in connection with representations, warranties and indemnification. The point is to stay involved in the documentation and be sure your advisors thoroughly explain the amount and duration of your potential exposure.

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