What to Do When a Seller Breaches Your Purchase Agreement

If you’re in the process of buying another business, you realize there’s a lot that could go wrong with the business you’re buying, and a lot the Seller might not be telling you about risks and problems of that business.  And you realize that those risks and problems might cost you, the Buyer, real money and heartache down the road.  So how can you protect yourself?

Get “Reps” from the Seller.

For starters, you can ask the Seller to give you so-called “representations and warranties” (or “reps” for short) about the business – essentially, these are statements of fact in the purchase agreement about specific aspects of the business.  For example, you can ask the Seller to represent that the business has complied with all applicable laws, or that there is no ongoing litigation that is likely to harm the value of the business after you buy it.

A Rep’s Been Breached – Now What?

It’s one thing to get representations from the Seller, and another to actually collect damages from the Seller if a representation turns out to be wrong and you suffer financial harm as a result.  So how would you collect damages from the Seller in that situation?

One approach would be to sue the Seller for breach of contract, with your claim sounding something like this: “your representation was false, I suffered harm as a result, so you owe me lots of money because you breached our contract.”   The problem with suing the Seller, of course, is that litigation is often terribly expensive and can lead to unanticipated complications and unwanted outcomes.

Seek Indemnification!

Another approach, and one that is more common, is to seek “indemnification” from the Seller under specific terms in the purchase agreement.  “Indemnification” sounds like a dry, legal term (and in some respects, it is!).  In fact, to the uninitiated, indemnification provisions in purchase agreements can seem to be long, turgid, boilerplate provisions with enough legalese to put even the most enthusiastic young lawyer to sleep.  But here’s the rub:  this section can mean real dollars to you as the Buyer, so it’s absolutely critical that you understand what it is and how it works.

Sounds Great – But What Does That Even Mean?

Indemnification is a contractual right under your purchase agreement that gives you, the Buyer, the right to seek reimbursement (“indemnity”) from the Seller for damages you suffered because either (i) the Seller breached the purchase agreement or (ii) a third party sues you after you buy the business for things you’ve agreed with the Seller should not be your responsibility (for example, manufacturing defects in products made by the Seller prior to closing).

These indemnification terms include, among other things, the types of harm for which the Buyer can recover damages, limits on the amounts that the Buyer can recover, limits on the time period during which the Buyer can make claims for indemnification from the Seller, and procedures for making claims.

With that introduction behind us, lookout for my next post on indemnification, where we’ll get into some key aspects of indemnification that will help you gain a much stronger understanding of this most critical aspect of your deal.

In conclusion, as a Buyer, you need to make sure you understand what indemnification is, whether your indemnification rights are adequate in light of the risks you face in buying the Seller’s business, and how to negotiate for the best possible protections.  And be sure you have a legal advisor who understands how to help you in this most important area.

Photo by Tax Credits on Flickr

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