Short answer. The warranty of assets and liabilities is the clause by which the seller of a company’s shares undertakes to indemnify the buyer if an undisclosed liability appears, or if an asset turns out to be worth less than represented, for a cause predating the sale. It is essential because ordinary law protects the buyer of shares poorly: the warranty against hidden defects does not apply to shares, and fraud requires proving intentional concealment. An effective warranty rests on four negotiated parameters: its duration, generally three to five years, aligned with the tax authorities’ reassessment periods; its cap, often between 10 and 30 percent of the price, with a triggering threshold and a deductible; its enforcement mechanism, which confines claims within set deadlines and formalities; and the security backing it, a bank guarantee, escrow or price holdback, without which it is only worth the seller’s solvency.
Buying a company’s shares means buying a legal person with its entire past: its contracts, its employees, its tax and social-security debts, its disputes, its off-balance-sheet commitments, its faults not yet sanctioned. The price was set based on accounts and representations; if those accounts are inaccurate or those representations incomplete, the buyer pays twice, once to the seller and once to the forgotten creditor. The warranty of assets and liabilities is the contractual mechanism that allocates this risk. This article explains what it covers, how its duration and cap are negotiated, how it is enforced, and what makes it ineffective. Our page on business acquisition and sale presents the cases the firm handles.
1. Why ordinary law is not enough
A buyer of shares might think they have the ordinary remedies of any purchaser. They do not. The warranty against hidden defects under Articles 1641 et seq. of the Civil Code applies to the thing sold; but the thing sold is a share, not the business. The Commercial Chamber of the Cour de cassation consistently holds that defects affecting the company’s activity or assets are not defects of the shares themselves, except where they render the company unfit for any operation at all, which is exceptional. A tax liability discovered after the sale, a loss-making contract, a protected employee unlawfully dismissed, none of these amount to hidden defects in the shares.
What remains are defects of consent. Article 1137 of the Civil Code defines fraud as obtaining consent through scheming or lies, and treats as equivalent “the intentional concealment by one contracting party of information which it knows to be decisive for the other party.” Article 1112-1 further requires a party who knows information that is decisive for the other to disclose it. These provisions support a nullity action or a claim for damages, but they require proving intent and decisiveness, which means a long and uncertain trial, and the text expressly excludes the valuation of the price: a seller who sold high has not deceived anyone. The contractual warranty replaces that burden of proof with a mechanism: the seller represents, the buyer establishes the inaccuracy, the indemnity is owed. Without a warranty, the buyer of a small or mid-sized company is almost without recourse; that is what our guide on defects of consent shows.
2. What the warranty covers: representations, liabilities, assets
A warranty of assets and liabilities has two parts. The first is a list of representations by the seller, the representations and warranties of Anglo-American practice: due incorporation and validity of corporate decisions, ownership and free disposal of the shares, accuracy of the reference accounts, absence of undisclosed liabilities, tax and social-security compliance, compliance with applicable regulations, intellectual property, ongoing contracts and the absence of change-of-control clauses, absence of litigation, employee matters, environmental matters, insurance, absence of any material event since the reference accounts. The second part is the undertaking to indemnify the buyer or the company for any inaccuracy in these representations and for any liability whose origin predates the sale and which was not provisioned for.
The distinction between a liabilities warranty and an assets warranty matters. A liabilities warranty covers the emergence of a new debt or the increase of an existing one; an assets warranty covers the reduction of a represented asset, an uncollectible trade receivable, unsellable inventory, an encumbered property. A balance-sheet warranty, broader still, covers any variation in net equity compared with the reference accounts. The choice between these formulas is not neutral: a balance-sheet warranty lets the seller offset a liability that has arisen against an undervalued asset, which a pure liabilities warranty does not allow.
The identity of the beneficiary also deserves attention. Where the indemnity is owed to the company, it restores the company’s assets but also benefits minority shareholders who remain in the capital; where it is owed to the buyer, it compensates the buyer’s own loss, but may be reclassified as a price reduction, with tax consequences. Contracts often give the buyer the choice between the two.
3. Duration: three to five years, and the tax deadlines
The warranty’s duration is the period during which a claim may be notified. Market practice sets two to five years for general representations, with longer specific periods for matters where the risk surfaces late. For tax and social-security matters, the duration is aligned with the authorities’ reassessment periods: for corporate income tax, the reassessment right runs until the end of the third year following the year for which the tax is due (Article L. 169 of the Tax Procedures Code), extended to ten years for undisclosed activity; social-security contributions are subject to a three-year period. An effective tax warranty therefore covers financial years not yet time-barred as of the sale date and runs until the reassessment period for the last covered year expires, plus a few months to allow for notification.
The warranty of title to the shares is generally given without any time limit, or for the ordinary five-year limitation period running from knowledge of the facts (Article 2224 of the Civil Code). A claim notified within the deadline preserves the buyer’s rights even if the liability is only finally quantified after the deadline expires: the clause must say so expressly, failing which the seller will argue that only a quantified claim stops the warranty running.
4. The cap, the threshold, the deductible
The seller will not accept an unlimited warranty. The cap fixes the maximum amount of indemnification, generally expressed as a percentage of the price: 10 to 30 percent is the most common range, up to 100 percent for fundamental representations such as title to the shares and the seller’s capacity, and uncapped in case of fraud. The triggering threshold, or basket, provides that the warranty only operates once cumulative claims reach a given amount, often 1 percent of the price; it comes with a de minimis threshold per claim, which screens out claims that are too small. The difference between a threshold and a deductible is decisive: with a threshold, once the amount is reached, the full amount is owed from the first euro; with a deductible, only the excess above the amount is owed. Many poorly negotiated warranties confuse the two.
Calculating the indemnity follows its own rules, which must be written into the clause: deduction of provisions already made in the reference accounts for the same risk, deduction of the tax savings the liability generates for the company, deduction of insurance proceeds received, exclusion of liabilities resulting from a subsequent change in the law or from a management decision of the buyer. Each of these deductions is a battleground at the time of a claim, and each must be settled at signing.
5. Enforcement: deadlines, formalities, disputes
The warranty contains a procedure. A buyer who becomes aware of a fact that may give rise to indemnification must notify the seller within a set period, often thirty or sixty days from becoming aware, and, where a third-party claim or a tax audit is involved, within a shorter period allowing the seller to take part in the defence. Late notification generally results in forfeiture only if it caused prejudice to the seller, but the strictest clauses make it a condition of the warranty itself. The notification must be reasoned, quantified as far as possible, and supported by documents.
The seller then has a right of oversight over the conduct of the dispute or the audit underlying the claim: the seller may ask to run the defence, at its own cost, or refuse a settlement it considers too generous. The buyer, for its part, wants to retain control over a dispute concerning a company it now runs. The clause organises this balance: mutual information, a right to participate, prior agreement on settlements above a given amount. Where the parties disagree on the amount of the indemnity, the contract often provides for an accountant acting as arbitrator on figures, and the commercial court or arbitration for the rest.
6. Security for the warranty: without it, the clause is worthless
A liabilities warranty is a claim against the seller. If the seller is a holding company that has distributed the price, an individual who has moved abroad, or a company that has been wound up, the buyer holds a right against no one. This is why negotiations focus as much on security for the warranty as on the warranty itself. The techniques are well known: an on-demand bank guarantee, issued by the seller’s bank for an amount and duration aligned with the cap and duration of the warranty; an escrow of part of the price held by a third party, released in instalments as deadlines expire; seller financing which the buyer can withhold by way of set-off; a pledge over the shares or other assets of the seller; and, in recent years, warranty and indemnity insurance taken out by the buyer or the seller, which transfers the risk to an insurer for a premium of 1 to 3 percent of the insured amount.
The effectiveness of set-off deserves a mention. Where the buyer still owes part of the price, it is tempting to withhold instalments up to the amount of its claim. Such a withholding is only lawful if the contract authorises it or if the conditions for statutory set-off are met, which requires a debt that is certain, liquidated and due; a disputed claim is not. A penalty clause, fixing a lump-sum indemnity in case of inaccuracy, is possible but remains subject to the court’s power to reduce it if it is manifestly excessive (Article 1231-5 of the Civil Code).
7. What makes a claim fail
Disputes over liabilities warranties are typically lost for recurring reasons. The buyer’s own knowledge: where the triggering fact appeared in the warranty’s schedules, in the data room or in the due diligence report, the seller will argue the buyer accepted it and priced it in; the clause must specify whether the buyer’s knowledge excludes the warranty or not, and the schedules must be reread with that risk in mind. Late notification, where the clause makes it a condition. Failure to give reasons or to quantify the claim. A liability arising from a cause predating the sale but revealed by a management decision of the buyer, which clauses often exclude. And the limitation period for enforcing the warranty, five years from the claim or its rejection, which gets forgotten during a negotiation that drags on.
Conversely, fraud by the seller lifts every cap and every limit: a liability knowingly concealed opens, beyond the warranty, a nullity action for fraud and the personal liability of the directors who certified inaccurate accounts. The buyer’s strategy is then to choose between enforcing the warranty, quick but capped, and a fraud action, longer but unlimited. Our page on shareholder disputes describes situations where the seller remains a shareholder and these two paths combine with a dispute between shareholders.
8. Negotiating the warranty: what matters for the buyer, what matters for the seller
For the buyer, the order of priorities is as follows: security for the warranty, ahead of the cap; the definition of the guaranteed liabilities, which should include unprovisioned liabilities of every kind; the absence of a knowledge clause; aligning durations with the tax deadlines; and a workable claims procedure. For the seller: a reasonable cap, a threshold rather than a deductible if possible, a precise list of exclusions, the right to run the defence, and a progressive release of the securities. The price of a generous warranty is a higher sale price; the price of a weak one is a discount. The warranty is a component of the price, and is negotiated as such, alongside it rather than after it.
The warranty of assets and liabilities is part of the wider sale process, whose other stages, letter of intent, due diligence, agreement, closing, are described on our business acquisition and sale page.
Are you negotiating a sale, or have you just discovered a liability in a company you acquired? In the first case, the warranty is built alongside the price; in the second, the notification deadline is already running. An initial conversation is enough to assess what the clause actually allows. Tell us about your situation.
Frequently Asked Questions
What is the usual duration of a warranty of assets and liabilities?
Two to five years for general representations, aligned with the tax authorities’ reassessment periods for tax and social-security matters: three years after the tax year for corporate income tax (Article L. 169 of the Tax Procedures Code), plus a few months for notification. The warranty of title to the shares is generally given without a time limit.
What is the usual cap on a liabilities warranty?
Between 10 and 30 percent of the sale price for general representations, up to 100 percent for fundamental representations (title to the shares, capacity), and uncapped in case of fraud. The cap comes with a triggering threshold and a minimum amount per claim.
What is the difference between a threshold and a deductible?
With a threshold, the warranty operates from the first euro once the cumulative amount of claims reaches the set amount. With a deductible, only the excess above that amount is indemnified. The difference can represent several percentage points of the price.
Can I take action without a liabilities warranty if a hidden liability appears?
With difficulty. The warranty against hidden defects does not apply to share sales, unless the company is rendered unfit for any operation. What remains is an action for fraud (Article 1137 of the Civil Code) or for breach of the duty of disclosure (Article 1112-1), which requires proving intentional concealment of decisive information.
How can I be sure the seller will be able to pay the indemnity?
Through security for the warranty: an on-demand bank guarantee, an escrow of part of the price released in instalments, seller financing subject to set-off, a pledge, or warranty and indemnity insurance. Without it, the clause is only worth the seller’s solvency on the day of the claim.