In practice, the agreed-upon liability provisions determine what a buyer can actually recover in the event of a breach of warranty. It is precisely on this point that the interests of the buyer and seller fundamentally diverge.
Conflicting Interests
After the transfer, the seller wants a clean slate as quickly as possible: short time frames, high thresholds, and a low liability cap. The buyer wants the opposite.
This tension begins with the classification of the warranties themselves. Sellers try to classify as many warranties as possible as “operational,” because shorter time limits (typically eighteen to twenty-four months) and lower caps apply to that category. Buyers, on the other hand, want to upgrade to “fundamental” warranties, which touch on the core of the transaction—such as the seller’s authority and the unencumbered status of the shares—for which terms of five to ten years apply.
Tax warranties generally align with the Tax Authority’s period for assessing additional taxes. Those who fail to negotiate this point carefully will only realize it when something goes wrong.
Thresholds
Virtually every sales contract contains financial thresholds. The de minimis clause completely excludes individual claims below a certain amount. The basket clause stipulates that the buyer can only file a claim once the total of all claims exceeds a threshold amount.
The type of basket that applies makes a significant difference: with a tipping basket, if the threshold is exceeded, the buyer may claim the full amount of damages, including amounts below the threshold. With a deductible basket, the buyer can only recover the excess amount. For fundamental warranties, the financial thresholds generally do not apply, which is another reason why the qualification discussion is so important.
Cap and Role of W&I
The cap limits the total amount a buyer can recover through warranty claims, regardless of the actual damages. In transactions involving warranty and indemnity (W&I) insurance, this dynamic changes. The W&I policy assumes the seller’s liability up to the insured amount. For sellers, especially in private equity exits, this is attractive: they aim for a low contractual cap and a clean break without long-term liability risks.
For buyers, an W&I policy has a downside that is often underestimated. The policy terms do not automatically align with the set of warranties in the purchase agreement. A claim that is contractually valid may be rejected by the insurer, for example, because the risk was known from the due diligence review. The W&I policy supplements the contractual protection; it does not replace it.
Information Provided and Scope of Warranties
In many sales agreements, the scope of the warranties is defined by what the seller has disclosed to the buyer, whether through a data room or by other means. However, a seller’s assertion that information has been disclosed does not in itself prove that the buyer actually recognized the risk. A document buried among thousands of other files, or one from which a risk becomes apparent only after further analysis, generally does not automatically qualify as “disclosed.”
Merely making information available is not the same as actually being aware of the risk. The wording in the purchase agreement is therefore crucial: does it refer to what was “known to the buyer,” or is all the data room material considered known? These are fundamentally different starting points.
An issue known to the buyer prior to the transfer does not constitute grounds for a claim under the warranties. In such situations, an indemnity may be invoked. An indemnity is specifically intended for specific, known-in-advance risks and enables the buyer to recover damages resulting therefrom. Indemnities generally have fewer limitations, both in terms of duration and liability cap.
Conclusion
The set of warranties determines the grounds on which a buyer can file a claim; the liability provisions determine what can actually be recovered. The classification of warranties, the type of basket, the cap, the W&I policy, and the scope of the information provided collectively form the playing field on which the buyer and seller have conflicting interests.
Anyone who views the liability provisions as a technical formality and gives too much ground in the final phase of negotiations risks losing an otherwise well-negotiated deal if unexpected issues come to light after closing.
