In M&A transactions, sellers routinely seek to limit their exposure under warranties and indemnities via reasonably standard exclusions and limitations. This article focuses on two of the most fundamental warranty limitations: time limits and financial caps. It draws from the findings of the DLA Piper 'Global M&A Intelligence Report 2016' (Report).
Warranty Time Limits
In recent times we have observed the increasing use of different time limits for different categories of warranties:
- 'Fundamental' warranties usually relate to the seller's authority, capacity and title (but they can include other warranties that the buyer is particularly concerned about in the circumstances, and are often subject to longer, or even no, limitation periods. The Report observed significant differences by region on the time limits that are being agreed for fundamental warranties. In the US, longer limitation periods appear to be the norm, with fundamental warranties surviving for more than six years in 80% of the surveyed US deals. In contrast, Europe seems to be more tolerant of shorter time limits for fundamental warranties. New Zealand tends to follow the European approach, with fundamental warranties often surviving for longer periods than commercial warranties, but rarely as long as six years.
- 'Commercial' warranties tend to relate to the condition of the target’s business, assets and operations, including warranties relating to financial statements, business contracts, employees, insurance, litigation and consents. Regarding time limits applying to commercial warranties, we have observed a much more consistent approach globally with limited regional variance. The Report observed that 90% of surveyed deals had time limits of two years or less for commercial warranties (and 65% of surveyed deals had time limits of 18 months or less), highlighting the increasing difficulty buyers have in trying to negotiate a period that will cover multiple audit cycles of the target. In our experience, New Zealand market practice mirrors global trends. Buyers typically seek a time limit that extends beyond two audit cycles for the target business, entity or group. However, sellers are increasingly finding success in agreeing shorter time limits.
- Warranties relating to the payment of tax and the separate 'tax indemnity' are usually subject to longer time limits, typically tied to the tax authority enquiry periods in the relevant jurisdictions. In New Zealand the limitation period agreed for such claims is typically between six and eight years.
Naturally, various other factors have an influence on warranty time limits. In particular, the Report revealed (not surprisingly, given the competitive tension) that sales by auction processes generally result in shorter commercial time limits (60% of surveyed auction sales had time limits of up to 18 months, but this percentage dropped to 42% for non-auction sales). Other factors that influence agreed time limits include: the type of seller (e.g. PE v trade); and whether or not warranty and indemnity insurance is obtained.
Warranty Financial Caps
Financial caps on warranty claims usually comprise an overall financial cap, a 'de minimis' (or small claims exclusion) and an aggregate (or 'basket') threshold.
In terms of overall financial caps, from the Report:
- As with time limits, we observed differing approaches for fundamental, commercial and tax warranties. Globally, in around 30% of the surveyed deals, fundamental warranties had higher financial caps (typically 100% of the purchase price, but in some cases no cap) than commercial warranties.
- In over half of the surveyed deals, the cap on commercial warranties was 40% of the purchase price or less. However, in the US, we saw significantly lower caps, with the significant majority of deals having caps of 20% of the price or less.
- Sales via auction processes also generally drove a lower cap, with 63% of all auctions having a cap of 20% of the price or less, although we expect that this effect may have been skewed by the fact that auctions are often used on larger deals and the percentage caps are generally lower on larger deals.
- The type of purchaser also has an impact. PE sellers had far more deals where the cap was 20% of the price or less. PE buyers also accepted lower caps in the majority of their acquisitions. When it came to trade buyers, overall, we observed a third of trade buyers expecting to buy or sell with a 100% cap, although this trend also dropped away on larger transactions (with just 6% of trade buyer deals having a cap of 100% of the price when the price exceeded EUR 100 million).
In New Zealand during 2016, we saw greater variance with financial caps ranging from 10% to 100% of the purchase price, with the larger deals generally resulting in lower percentage caps.
In terms of the 'de minimis' and aggregate thresholds, from the Report:
- We saw significant regional variations, with only 35% of US surveyed deals even having a 'de minimis', compared to more than 80% of non-US surveyed deals.
- The majority of deals surveyed globally had 'de minimis' thresholds of less than 0.1% of the price. However, this trend is skewed by US deals, which generally went further with thresholds of less than 0.05% of the price.
- In 85% of the deals surveyed globally, there was an aggregate claims threshold, being an amount which claims must exceed in aggregate before any claims can be brought against the seller.
- At a global level, a 'trigger' or 'first $ basket' approach (where the buyer can claim back to the first dollar, once the basket threshold is crossed), was much more common than an excess approach (where the buyer can only claim above such excess), although there were regional variances. In Australia and most European jurisdictions (not France, Germany or Italy), the vast majority of deals took a 'first $ basket' approach, whereas France, Germany and Italy use both 'first $ basket' and excess approach equally commonly. US deals tended to slightly favour an excess approach (60% of the surveyed US deals).
The above trends are relatively consistent with our experience in New Zealand during 2016:
- All of the deals we worked on had a de minimis and an aggregate claims threshold.
- Generally, the de minimis was in the region of 0.1% of the purchase price and the aggregate claims threshold in the region of 1% of the purchase price, although these percentages drop on larger deals.
- Although we did work on a couple of transactions where an excess approach was agreed, a 'trigger' or 'first $ basket' approach remains much more common in New Zealand.
It is also worth noting that in New Zealand, it is common for certain limitations, in particular the financial caps, not to apply in respect of any claims arising from the fraud of the seller.
In addition, there are a number of resources that we can make available to our clients and contacts including for example, the DLA Piper online guide to global M&A (a tool-kit providing an overview of key M&A issues in most significant jurisdictions across the globe). To access this resource, please click here.
We look forward to publishing the DLA Piper 'Global M&A Intelligence Report 2017' later this year and presenting its key findings to many of you actively engaged in M&A.