Vendor Warranties When Buying a Business

Tuesday 7 September 2021

Below are some of the common vendor warranties in the purchase of a business. They are found in the Auckland District Law Society (ADLS) Agreement for Sale and Purchase of Business

Turnover Warranty

One of the most important vendor warranties is the turnover of the business because it affects the value of the goodwill and the sale price. The vendor will warrant the turnover for specified period(s). The vendor should inform the purchaser of any one-off increase in business activities which affect an otherwise accurate turnover value. Failure to inform the purchaser may amount to misrepresentation.

In the ADLS Agreement, such turnover warranty is purely historical. The vendor makes no warranty it will continue.

The ADLS Agreement contains a further warranty that the vendor will operate the business as a going concern. In which case, the vendor must use reasonable endeavours to maintain the turnover and preserve the goodwill of the business. Please refer to our article on Goodwill and its valuation for more information.

The average weekly turnover is often difficult to quantify - particularly for seasonal businesses, and turnover value can be a subjective valuation. It is important for purchasers to investigate the financial records of a target business before signing the Agreement, or at least make the Agreement conditional upon observing the business for a certain period.

Unencumbered property; licences and consents

The ADLS Agreement also includes a warranty by the vendor that all assets (tangible, intangible, stocks, and those listed in the Agreement) included in the sale are the property of the vendor, no monies are owing on any assets to third parties, and the vendor passes title in those assets to the purchaser. We carry out relevant searches to ensure all assets are the unencumbered property of the vendor on settlement.

The sale of a business which requires licences or regulatory consents to continue (e.g., environmental health or alcohol licences) should contain a vendor warranty that the licences or consents will remain in effect up the possession date and the vendor will facilitate the transfer of the licenses or consents to the purchaser.

Notices affecting the business

The ADLS Agreement contains a warranty that there are no notices or requisitions outstanding which adversely affect the business which have not been disclosed in writing to the purchaser. This would include notices from the landlord or requisitions, requirements, or town planning notices from local or government authority that has to do with the business or the premises. Purchasers would want to carry out their own searches and inquiries to identify if notices have been or might be issued. For example, it is especially important to check if there has been any requisition for food-based businesses.

Due diligence and further warranties

It is preferable, for purchasers to carry out due diligence instead of just relying on warranties. The risk of relying on warranties is that damages or compensation may not adequately cover the shortfall and are often difficult to calculate after the Agreement is signed. In some cases, the vendor company may already be wound up. Purchasers may opt in to a condition of due diligence. Clause 8.2 of the ADLS Agreement lays out what the due diligence investigation may (without limitation) consider.

It is best to include a warranty specifying the vendor has disclosed all material information necessary to decide in the purchase of the business. Such warranty may be provided on signing the Agreement, and repeated on settlement. Material facts may emerge after the Agreement is signed, but before settlement, which affects the value of the business. In that event, it is important to seek legal advice, to consider if legal arguments can be made to renegotiate the purchase price.

This article is for general use only. Advice should be sought for specific circumstances. Please consult Teresa Chan at Teresa Chan Law Limited, Level 3, Westpac Building, 106 George Street, Dunedin 9016, ph. 477 1069, or email teresa@tchanlaw.co.nz