Warranties in Contracts: why they really do matter!

A well-drafted contract for the sale of assets or a business will often include warranties that are provided by the Vendor to the Purchaser, such as warranties that the Vendor is the legal owner of the assets or that the assets are in good working order.

A recent case in the High Court of Australia (Clark v Macourt [2013] HCA 56) highlighted the importance of these warranties, which was good news for the Purchaser!

What happened?

The Vendor was a fertility company which agreed to sell its business to the Purchaser for around $400,000.00. The assets of the business included frozen sperm samples. The Purchaser was told that all the sperm samples were usable, and the contract included a warranty from the Vendor that all the samples complied with all the necessary regulations to allow them to be used.

However, the Purchaser later discovered that less than half the samples were compliant and could be used. This meant that the Vendor was in breach of its warranty to the Purchaser.

The Purchaser needed to spend over $1.2 million to buy replacement samples. Although they were able to recoup some of their losses from their clients, and despite the failed sperm samples comprising less than half of the original $400,000.00 purchase price, the High Court held that the Purchaser was entitled to damages to compensate for the full $1.2 million loss. It did not matter that this was a larger amount than the original purchase price for the business.

The key principle in these cases is that damages should be designed to put the plaintiff back in the same position they would have been in if the Vendor had not breached their warranty. In this case, the Purchaser had spent $1.2 million to put herself back in that position, so that was the amount of damages she was awarded.

In a further twist, the Director of the Vendor was included as a Guarantor in the contract and he had agreed to personally guarantee the Vendor's obligations under the contract. Because the Vendor company had already been placed in liquidation, the Purchaser sued the Director and he was ordered to pay the damages personally.

What you need to know!

Whenever you are buying assets or a business, make sure the contract contains all the necessary warranties to ensure you are getting what the Vendor promised. The wording of the warranties can make a big difference too.

Vendors need to be very careful to ensure they do not promise anything they cannot deliver or which might not be accurate. It also pays to ensure the contract is drafted carefully if the Vendor of the fertility business had capped their liability to the amount of the purchase price, the Purchaser's claim would have been much smaller.

Directors of Vendor companies need to be careful too, because if they agree to act as a Guarantor they can find themselves on the receiving end of a very costly claim!

If you are facing any of the issues that arose in this case, or would like to discuss any other concerns about your business, please contact Mitchell Zadow, Managing Principal and Accredited Specialist in Commercial Law, on (03) 8561 3318.

The information contained in this article is intended to be of a general nature only and should not be relied upon as legal advice. Any legal matters should be discussed specifically with one of our lawyers.

Liability limited by a scheme approved under Professional Standards Legislation.

For further information contact  
Mitchell Zadow

Mitchell is the Managing Principal of our law practice.

He is an Accredited Specialist in Commercial Law (accredited by the Law Institute of Victoria). He also deals with areas of Employment Law, Wills & Estate Planning and Probate. For further information, contact Mitchell on his direct line (03) 8561 3318.

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