Enforceability of warranties and indemnification in sale of business contracts

November 1st, 2022
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EBS International (Pty) Ltd and Another v Wright (WCC) (unreported case no 19128/2020, 9-5-2022) (Wille J)

It is often prudent that in any agreement, particularly sale of business transactions that there are certain warranties made by the seller in respect of the business to the purchaser vis-à-vis indemnifications provided to the purchaser by the seller. These warranties and indemnifications form a critical and integral part of the agreement as they operate as security to the purchaser in respect of any past, present, and future liabilities that may arise after the conclusion of the agreement.

On 9 May 2022, Wille J issued a decision in EBS International, which highlights the importance of having warranties and indemnifications in agreements of this nature. Wille J focuses on the application, enforcement, and execution of warranties, which were given by the shareholder/director in the sale of business as it related to the tax obligations and affairs of the company.

In this case, the seller signed warranties on the tax obligations and affairs of the company and with an indemnification to assume liability for any losses incurred by the purchaser as a result of a breach of the written warranties in the agreement of sale.

In terms of the agreement of sale, the seller (respondent) agreed and undertook through representation by way of warranties and indemnification that the company’s tax affairs and obligations were in order. It was only after the sale of business agreement was concluded that the purchaser (applicant) found that the company’s tax affairs and obligations to the South African Revenue Services (Sars) were in fact, not in order and that the company had a tax liability in excess of R 6 286 600,55 and a further R 4 219 108,27 which was due and payable to Sars.

The purchaser invoked the breach clause against the seller for breach of the warranty as it related to the tax affairs and obligations of the company in that the seller was not honest about the company’s tax obligations and it had now suffered a financial loss as result of such breach. Wille J ruled in favour of the purchaser and opined that:

‘The respondent [seller] breached his warranties under and in terms of the sale agreement (as at the effective date of the sale agreement) in that the second applicant [company] had not timeously, fully, or accurately accounted for and paid to the South African Revenue Services all its lawfully imposed obligations.’

In accordance with the indemnification clause – the seller agreed to be held liable for any damages suffered by the purchaser as a result of the reports, undertaking and warranties he made about the company’s tax affairs. In this regard, Wille J, reasoned and stated that:

‘Accordingly, the respondent [seller] is liable to indemnify the first applicant [purchaser] for all additional taxes, interest, penalties, and other charges assessed by the South African Revenue Services to be payable by the second applicant [company] in respect of the period before the effective date of the sale agreement. … [T]o indemnify the first applicant for all costs, charges, disbursements, expenses, and fees (including legal and other professional fees) incurred in investigating and remedying the second applicant’s breaches of its obligations.’

The proceedings teach us that contracts, are important when concluding any commercial transaction, particularly the importance of undertakings – given in such agreements, namely, warranties and indemnifications and that they are binding and have legal implications and consequences to the parties to the agreement.

As both can be comprehended: If not complied with or untruths statements are made in the conclusion of the agreement – warranties and indemnification give rise to a breach of contract and have a consequence of providing compensation for financial loss (ie, damages) for the aggrieved party to the agreement.

In EBS International, the judge applied the warranties and indemnification clauses of the agreement and held that the respondent had dismally breached these solely because the tax assessment proved that the respondent had intentionally failed to ensure that the second applicant complied with its tax obligations. The judge also found that the respondent had ample time before the tax assessment process to ensure that the second applicant was registered with Sars and made its tax payments in accordance with Sars requirements. However, the respondent instead paid himself dividends on an annual basis, implying that he intentionally refused to do so, resulting in a breach of the warranty and as such needed to indemnify the first applicant from the financial loss he suffered.

Conclusion

In this case, Wille J, opined that the seller did not take active and positive steps to ensure that the company met its tax obligations, despite the fact that the seller was the company’s sole director and shareholder. This case highlights the critical importance of compliance with warranties, as failure to do so will result in a breach of contract and damages as was held in EBS International.

Lusapho Yaso LLB (UWC) is a candidate legal practitioner at MRT Law Inc in Cape Town.

This article was first published in De Rebus in 2022 (Nov) DR 30.

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