What is the Difference Between a Warranty and an Indemnity?

What is the difference between a warranty and an indemnity?

In mergers and acquisitions (M&A) transactions, warranties and indemnities are crucial mechanisms for allocating risk between the buyer and the seller. While both serve to protect the buyer, they differ significantly in their structure and application.

Warranty

A warranty is a statement or assurance provided by the seller regarding specific aspects of the business being sold. These assurances typically cover areas such as ownership of the company and its assets, accuracy of financial statements, absence of undisclosed liabilities and compliance with applicable laws and regulations. A warranty can be understood as a contractual promise regarding the quality or condition of the assets at the time of sale.

If a warranty proves to be untrue, the buyer may claim damages for losses suffered as a result. However, the buyer must demonstrate that the warranty was breached and that the breach caused the loss. Additionally, the buyer is generally required to mitigate their loss. Warranties are often subject to limitations such as time frames, monetary caps, and thresholds.

Indemnity

An indemnity is a promise by the seller to compensate the buyer for specific losses arising from identified risks. Unlike warranty, indemnity claims typically do not require the buyer to prove breach of contract. However, depending on the jurisdiction and specific contractual terms, the duty to mitigate losses may still apply to indemnity claim. They are typically used to address particular risks, such as tax liabilities, pending or potential litigation, environmental issues regulatory non-compliance.

Indemnities offer more direct protection to the buyer, as they provide a clear path to compensation without the need to establish fault or causation. However, they often involve more negotiation to define the scope and terms clearly.

When undergoing M&A transactions, ensure you clearly define terms and allocate risks appropriately. Sometimes it is worth considering W&I (warranty and indemnity) insurance, or consulting a legal professional.

If you have any questions about warranties and indemnities, please do not hesitate to contact me. I am here to help.