Q&A: Share Purchase Agreements

Warranties, indemnities, conditions and completion mechanics — your questions answered

Q. What is a share purchase agreement? 

A share purchase agreement (SPA) is the principal legal document governing the sale and purchase of shares in a company. It sets out the terms on which the seller agrees to sell and the buyer agrees to buy the shares, including the consideration, the mechanics of completion, the warranties and indemnities given by the seller and the limitations on the seller’s liability. 

A well-drafted SPA will cover: the identity of the parties and the shares being sold; the consideration and how it is calculated; any conditions that must be satisfied before completion can occur; the obligations of both parties between exchange and completion; the seller’s warranties about the state of the business; any specific indemnities for identified risks; limitations on the seller’s liability; and post-completion obligations such as non-compete restrictions. 

The SPA is usually accompanied by a disclosure letter (in which the seller qualifies the warranties by disclosing specific matters), a tax covenant or tax deed, and potentially a suite of ancillary documents including employment agreements for retained management, property transfers, and IP assignments. 

Q. What warranties are typically given in a share purchase agreement? 

Warranties in an SPA are contractual assurances given by the seller about the state of the target company. If a warranty proves to be untrue and the buyer suffers loss as a result, the buyer has a claim in damages. Warranties cover a broad range of matters and typically run to many pages in a mid-market SPA. 

The main categories of warranty include: 

• Title warranties — confirming that the seller owns the shares being sold, free from encumbrances, and has the legal capacity to sell them. 

• Accounts warranties — confirming that the most recent audited accounts present a true and fair view of the company’s financial position. 

• Trading warranties — confirming that since the last accounts date the company has traded in the ordinary course of business and there have been no material adverse changes. 

• Contracts warranties — confirming that there are no material contracts that will terminate or be affected by the change of ownership, and that the company is not in breach of its material contracts. 

• Employment warranties — confirming the accuracy of the disclosed employee information, the absence of undisclosed bonus or benefit arrangements, and the absence of active employment disputes. 

• Intellectual property warranties — confirming the company’s ownership of (or right to use) its key intellectual property, including trade marks, software, databases and domain names. 

• Tax warranties — confirming that the company’s tax affairs are in order, all returns have been filed and all tax due has been paid. 

• Litigation warranties — confirming that there are no current or threatened legal proceedings against the company. 

• Property warranties — confirming the accuracy of the disclosed property interests and the absence of material disputes with landlords or neighbours. 

The scope and detail of warranties is heavily negotiated. Sellers seek to limit them; buyers seek the broadest possible protection. 

Q. What is the difference between a warranty and an indemnity in a share purchase agreement? 

This is one of the most important distinctions in SPA law, and one that has very practical consequences for how claims are assessed and what the buyer can recover. 

A warranty is a contractual promise that a statement of fact is true. If the warranty is breached, the buyer’s remedy is a claim in damages for the diminution in value of the shares — the difference between what the buyer paid and what it would have paid had the warranty been true. The buyer must prove breach, quantify the loss on a ‘diminution in value’ basis, mitigate its loss, and act before the claim becomes statute-barred. Disclosure against a warranty defeats the claim. 

An indemnity is a contractual promise to reimburse the buyer pound-for-pound for a specific loss if it occurs. The indemnity is triggered by the occurrence of the specified event, regardless of whether it amounts to a breach of warranty. There is no need to prove a reduction in share value, no duty to mitigate, and disclosure does not defeat the claim. The seller simply pays the loss. 

Indemnities are used for specific, identified risks — a known tax liability, an ongoing dispute, a disclosed environmental issue, or pre-completion conduct that may give rise to future claims. Warranties provide general protection across the business as a whole. 

Q. What is a disclosure letter and why does it matter? 

A disclosure letter is a document provided by the seller to the buyer at exchange of the SPA, setting out specific matters that qualify or override the warranties. Any matter that is fairly and specifically disclosed in the disclosure letter is deemed accepted by the buyer — it cannot subsequently form the basis of a warranty claim. 

The disclosure letter typically operates in two tiers. General disclosures refer to matters that are publicly available (such as filings at Companies House, the Land Registry, and HMRC) and are deemed known by the buyer. Specific disclosures are specific statements made by the seller against particular warranties, each supported by the relevant documents in a disclosure bundle. 

For sellers, the disclosure letter is critically important — it is the primary mechanism by which the seller limits its exposure under the warranties. A seller who fails to disclose a material matter may find itself liable for a warranty claim in respect of it, even if it genuinely believed the buyer was aware of the issue. 

For buyers, careful scrutiny of the disclosure letter is equally critical. Disclosures that are vague or generic (‘the company’s contracts are as disclosed in the data room’) may not be sufficiently specific to qualify a warranty — but a buyer who signs without properly reviewing the disclosures may find it difficult to argue that a disclosure was inadequate after the event. 

Q. How is the consideration for a share purchase calculated and adjusted? 

The consideration in a share sale can be structured in various ways, depending on the commercial preferences of the parties and the nature of the business being acquired. 

Fixed price — a single sum agreed at exchange, payable at completion. The simplest structure but provides no mechanism to reflect the actual financial position of the business at the time of completion. 

Completion accounts mechanism — the price is adjusted after completion to reflect the actual working capital, net debt and/or net assets of the business at the completion date, compared to a target figure agreed at exchange. This is the most common mechanism for mid-market transactions. 

Locked box mechanism — the consideration is fixed by reference to a historical balance sheet (the ‘locked box’ date), and the buyer takes economic risk and benefit from that date. Between the locked box date and completion, the seller is prohibited from extracting value from the business (known as ‘leakage’). Increasingly common in private equity transactions as it provides price certainty. 

Deferred consideration / earn-out — part of the price is deferred and payable after completion, either unconditionally (on a fixed date) or contingently (subject to performance targets being met). See the separate chapter on deferred consideration and security. 

The appropriate mechanism depends on the nature of the business, the parties’ relative bargaining positions, and the risk appetite on both sides. Buyers generally prefer a completion accounts mechanism (which adjusts for the actual position at completion); sellers generally prefer a locked box (which provides certainty).