Warranties and indemnities – your questions answered

As part of our In-House with You monthly Q&A series, Partners from our Commercial, Corporate and Dispute Resolution teams spoke about the key differences between warranties and indemnities in your contracts and best practice for implementation. The slides can be accessed here.

Alison Scott and Elizabeth Beatty answer some of your key questions from the session below:

Are there any common mistakes that you see in the use of warranties/indemnities? If so, how can they be avoided?  

Where a party is seeking contractual warranties, we’d typically recommend that the party focuses on aspects of risk which (i) it is materially concerned about but has no visibility of (and cannot mitigate; and (ii) that the counterparty has knowledge of and/or control over (and the ability to mitigate). By contrast, a party giving a warranty should be mindful that it only gives warranties in respect of matters that it has knowledge of and/or control over (and the ability to mitigate). It is not advisable to ‘casually’ give warranties in respect of matters that do not fulfil those criteria and ‘hope for the best’.

A party should seek an indemnity where it considers that the counterparty should bear a particular risk or loss. This typically happens when, by entering into a contract, a party is exposed to a risk that can only arise because of the acts or omissions of its counterparty. By contrast, we often see parties seeking indemnities in other situations – for example, covering the consequences arising from breach of contract. Parties should challenge the inclusion of such indemnities on the basis that any such breach will give rise to a contractual claim for damages.

What are the pitfalls, if any, when drafting a basic indemnity?

The tendency is to try and make an indemnity in a share or asset purchase agreement as wide as possible. However, given that an indemnity is there to cover a specific risk highlighted as part of due diligence, it is better to try and be very specific about the risk that you are trying to cover. For example, if you discovered – as part of the due diligence exercise –  that there was a defect in the registration of a trade mark in certain jurisdictions (but others were fine), instead of including general wording such as ‘any claim in respect of the ownership of the trade marks’, it would be better for the buyer to specify that the indemnity was in respect of ‘any claim brought by a third party in respect of the failure to register properly the trademark in [the relevant jurisdiction]’.

How easy is it to claim under an indemnity? What does this process look in practice?

Claiming under an indemnity is, in theory, straightforward. Once the indemnified loss has been suffered, the receiving party will need to notify the paying party and demand payment.   It is important to check the contractual wording carefully, as it may contain provisions about how and when notice is given, and whether there is a duty to prove loss or causation or mitigate the loss. In practice, it is sensible to provide evidence that the trigger event has incurred and that the loss has been suffered. Depending on how the indemnity was drafted, the paying party may try to challenge the sum claimed. The wider the indemnity, the more likely it is that a dispute on quantum may arise.

What are the potential legal costs for taking a warranty claim to court? Do the cost risks generally outweigh the benefit? 

Each claim for a breach of warranty will need to be considered on its own terms, taking account of the quantification of damages, evidential issues and of course any limitations of liability and potential defences. 

Warranty claims can be very complex, requiring significant disclosure of documents, witness evidence and often expert evidence on quantum. As a ballpark figure, the costs of taking a substantial indemnity claim to trial could easily exceed £100,000 plus VAT (including court fees and counsel’s fees), perhaps significantly so, and it could take more than two years to reach trial. 

Most claims settle before trial and often without proceedings being issued at all. It may be worth notifying the other party of a claim with a view to reaching a settlement without the need to issue proceedings.

In some cases, a breach of warranty will not give rise to a significant claim for damages and may not be worth pursuing. However, where there is a breach of warranty and the asset is worth significantly less than the warranted price, it will certainly be worthwhile taking action.