How does a contractual liability cap work in a business sale?

A purchase agreement does not leave the seller exposed without limit. BDC, the federal Crown lender, notes that the seller of a business is not liable for misrepresentations forever and that the seller’s liability is typically capped at a certain percentage of the purchase price. The cap and the time limit are two separate protections, and both are bargained for.

Where the cap sits in the agreement

BDC describes the indemnity section as an important and hotly negotiated part of the agreement. It sets the ground rules for the compensation the seller pays if the seller’s disclosures turn out to be inaccurate or if covenants are not respected. The cap is one of those rules. BDC says the focus shifts to representations and warranties, indemnities and closing conditions once due diligence is substantially complete and the lawyers draft the binding agreement.

Why a cap changes what the seller keeps

BDC’s guidance on negotiating a sale says these clauses can significantly affect the net value the seller receives, even when the main price is settled. Ask your advisors how a higher cap or a longer exposure period would change what you keep. BDC also says market norms on indemnity have changed substantially in Canada in recent years, and that sellers and buyers should use advisors who are up to date on them.

How it links to holdbacks and the buyer’s protection

BDC notes that parties decide how much of the price is paid at closing and how much is held back in escrow or made subject to conditions. Ask how any holdback relates to the cap, and how long the funds stay held. From the buyer’s side, BDC says a buyer can protect against unforeseen liability by getting an indemnity from the seller that runs for a period after the sale.

Questions to put to your lawyer

• What is the cap measured against, and does it apply to every kind of claim or only some?
• How long after closing can the buyer make a claim?
• Which statements are given flatly, and which are qualified by what the seller knows?
• Is any part of the price held back, and does that sit inside the cap or on top of it?

The disclosure schedules, described in what disclosure schedules are, list the issues the seller has disclosed. BDC says the parties also negotiate who will assume the risks for those disclosed issues, so ask how each one is treated alongside the cap.