D6.442 Administration—warranties and indemnities on a management buy-out
The prospective purchaser in an MBO will wish to consider whether warranties or indemnities are required from the vendors, in respect of transactions occurring before the purchase. Warranties cover commercial issues, such as the company's profitability and the state and nature of the assets and liabilities, as well as taxation issues. Tax warranties are essential and should cover all taxation aspects. The main purpose of drafting comprehensive warranties is to ensure that all relevant information about Target has been identified.
In contrast to a warranty, a tax indemnity is a specific agreement by the vendor to make a payment to the purchaser if a specified liability arises in the future. In order to bring an indemnity claim, the purchaser only has to show that circumstances set out by the indemnity have occurred. For a warranty, the purchaser has to show that he has suffered some sort of loss or damage.
The indemnity should ensure that the vendor will settle any unexpected tax liabilities arising in Target (usually being liabilities that are not reflected in the tax provisions in the accounts relevant to the deal (whether normal account or completion accounts)), and it should cover all taxes including corporation tax, VAT, PAYE, National Insurance contributions, inheritance tax, stamp duty and foreign taxes. Usually, such an indemnity should be drafted as a deed of covenant between the purchaser and the vendor, whereby the vendor agrees to make a payment to the purchaser should certain liabilities