When buying or selling a small business, like a dental office, it’s crucial to understand the legal concepts of representations, warranties and indemnities. These terms can play a significant role in protecting both parties in the transaction. This blog will explain what representations, warranties and indemnities are and why they matter.
What Are Representations and Warranties?
Representations and warranties are types of statements in a purchase agreement that provide assurances about specific facts or conditions of the business being sold.
- Representations are factual statements one party makes to help persuade the other party to enter into a contract. As defined in case law, a representation is “an express or implied statement of fact which is influential in bringing about the agreement“.
- For example, the seller might represent that their dental office is in good financial health, collects all insurance co-pay, and has been operating in full compliance with all laws and College regulations.
- Warranties are legally enforceable promises that certain facts are accurate as of a specific date.
- If a warranty is false, the buyer may have a right to sue for damages or cancel the contract, depending on the importance of the warranty and/or the severity of the breach.
When selling a dental practice, these statements are often bundled together in the agreement of purchase and sale and are essential for both parties. They help clarify what is being sold and ensure transparency between the buyer and the seller.
How Representations and Warranties Protect Buyers and Sellers
At DMC, we review and draft extensive representations and warranties day in and day out. From our experience, we know that robust representations and warranties are among the most important portions of a business purchase and sale agreement for several reasons. Let’s explore a few of those reasons.
Risk Allocation
Well-drafted representations and warranties help to allocate risks fairly between the buyer and the seller. For instance, if the seller warrants that there are no ongoing lawsuits against the dental office, the buyer can rely on this assurance and proceed with taking out an expensive loan to finance their purchase without worrying about paying for the seller’s lawsuit. If this statement turns out to be false, the seller would be liable for any resulting losses.
Legal Protection
If a key representation or warranty is breached, the non-breaching party may have legal recourse against the representor/warrantor. This could include terminating the contract or seeking financial compensation (e.g., through a court process) for any losses incurred.
Due Diligence
Representations and warranties serve as a critical part of the due diligence process. They provide a basis for buyers to investigate their target business thoroughly and verify that the seller’s assurances are accurate and transparent.
In 2019, the Ontario Court of Appeal examined the interplay between due diligence and representations/warranties.
The appellants in this case had sold tree farm assets to the respondents pursuant to an asset purchase agreement. As part of the schedules attached to the agreement, the appellants had included an inventory listing of saleable trees, which turned out to be inaccurate by ~83,106 fewer trees than expected.
The respondents argued that the number of saleable trees per the inventory was a representation that they had relied upon and that the shortfall was effectively a breach of contract. The appellants, however, argued that the inventory list did not form a representation or warranty, but rather was a matter of the buyer’s due diligence.
The Court of Appeal agreed with the appellants, particularly because the buyers had included a representation acknowledging that they had concluded their own due diligence and had satisfied themselves enough to proceed with the purchase. In the decision, the Court of Appeal noted that the wording of the representation clearly included that the buyers were satisfied with the “quantity and quality” of the trees:
The above case study shows that parties to transactional documents should always review the representations and assurances they are (supposedly) agreeing to instead of relying solely on the other party not to make mistakes or miscalculations.
Examples of Representations and Warranties in a Dental Practice Transaction
When transacting for a dental office, the buyer and seller typically include several key representations and warranties in a purchase agreement. Here are some examples:
- Financial Statements: The seller represents and warrants that the financial statements of their office are accurate and fairly reflect the business’s financial condition.
- This means that the seller guarantees the numbers presented are correct and complete. If the financial statements are inaccurate or misleading, the buyer may suffer a financial loss and can seek compensation from the seller.
- Condition of Assets: The seller represents that the equipment, tools, and other assets used in the dental office are in good working condition.
For example, this could cover dental chairs, X-ray machines, or computer systems. If, after the purchase, the buyer discovers that the equipment is faulty or outdated, they could claim a breach of warranty. - Employee Matters: The seller represents and warrants that they will have provided a complete and accurate list of all of their employees and/or contractors and that there will not be any pending or ongoing and unresolved lawsuits, Ministry of Labour issues, or other employee matters outstanding leading up to the closing.
- The seller typically warrants that there are no disputes with current or former employees and that all employee obligations (such as wages and benefits) have been met. If this turns out to be false, the buyer could be liable for unpaid wages or face legal claims from employees.
By defining these terms, both parties minimize risks and establish a solid foundation for the agreement.
What Are Indemnities?
An indemnity is a promise by one party (usually the seller) to compensate the other party (usually the buyer) for certain losses or damages. It acts as a financial safeguard to protect against specific risks that may arise after the sale of the business.
Indemnities are usually included alongside representations and warranties in purchase-and-sale agreements to ensure that the buyer does not suffer financially from any unexpected issues related to the business that existed before the purchase date or from specific agreed-upon risks.
How Indemnities Safeguard Dental Practice Transactions
With proper indemnities in place, both parties can focus on the future, knowing they’re protected against unforeseen issues.
Managing Post-Closing Risks
Indemnities help manage and allocate risks between the buyer and the seller. They ensure that if certain issues arise after the sale, the responsible party will bear the financial burden.
Buyer Assurance and Confidence
Indemnities provide the buyer with a layer of protection against unknown or hidden liabilities that might surface after the purchase, such as unpaid taxes or legal disputes.
Limiting Seller Liability
For sellers, clearly defined indemnities with ceilings or set thresholds for damages can help limit their liability to specific issues or amounts, making it easier to predict and manage potential post-sale obligations.
It is of utmost importance that any indemnity between parties be specifically negotiated and agreed to in writing. A 2015 Superior Court of Justice decision shows the dangers of assuming a blanket indemnity for something that was not agreed to in writing.
In this case, the seller sold his dental practice through a brokered deal. The transacting parties agreed to a set of standard representations and warranties and a blanket indemnity,y which stated that the seller would promise to cover the buyer financially “in respect of any misrepresentation or breach of any warranty, agreement, covenant or obligation of the Vendor or the Corporation contained in this [share purchase agreement] or the schedules hereto […]“.
Not long after the purchase and sale agreement was finalized and the deal closed, two of the dental practice’s former employees sued the buyer for wrongful dismissal. The buyer turned to the seller for indemnification, but the Court disagreed, noting that there is “no sensible connection in law or in fact” between the employees’ wrongful dismissal claims and the blanket form indemnity from the seller for pre-closing matters.
Examples of Indemnities in a Dental Practice Transaction
Let’s explore how indemnities can address specific risks in dental practice sales.
- Tax Indemnities: A seller typically agrees to indemnify a buyer for any unpaid taxes that the dental office owes up to the date of sale. This indemnity protects the buyer from unexpected tax liabilities. For instance, if an audit reveals unpaid taxes from prior years, the seller would be responsible for covering those costs.
- Indemnities for Breaching Representations/Warranties: If the seller breaches any of the representations or warranties made in the purchase agreement, the seller may agree to indemnify the buyer for any resulting losses. This might include legal fees, fines, or costs associated with bringing the dental office into compliance.
- Employee-Related Indemnities: In perhaps the most hotly disputed indemnity, a seller may agree to compensate the buyer for any claims arising from the employment of current or former employees up to the date of sale. In some cases, buyers and sellers could even agree to split or share in any termination costs for a set period after closing.
- Employee-related indemnities could cover unpaid wages, wrongful dismissal claims, or disputes over benefits. If a former employee sues for unpaid overtime that accrued before the sale, the seller would need to cover the related costs.
Tailored indemnity clauses not only clarify responsibilities but also build confidence between parties. A well-constructed indemnity framework sets the stage for a smooth transaction for all involved.
Bottom Line
When buying or selling a small business like a dental practice, understanding representations, warranties and indemnities is critical. They provide a foundation for trust and transparency between the buyer and seller and protect both parties from unforeseen risks. If you’re considering a purchase or sale, it’s essential to work with a knowledgeable dental lawyer to ensure that the representations and warranties in your agreement are accurate, comprehensive, and enforceable. By including clear and specific representations and warranties in your share purchase agreement, you can help protect yourself from potential disputes and ensure a smoother transition of ownership.
Are you ready to buy or sell a dental practice? At DMC, we specialize in supporting dentists with every legal aspect of buying or selling a practice. Reach out today for a free consultation to see how we can safeguard your interests and help you navigate the complexities of transactions with confidence.
