April 18th, 2011
Look out for Warranty Liabilities in Acquisitions
Whenever a company is acquired, the treatment of past customer warranties, and the claims from those warranties, is always a critical issue. The seller has the incentive to shed as much liability for those warranty claims as possible, while the buyer desires the opposite outcome. The third set of stakeholders – existing and past customers – wish to see the warranties passed along to the buyer intact.
Sales of companies can either be structured as a sale of the stock of the company or the underlying assets, which has a significant impact on how warranty obligations are treated. In a stock deal, every aspect of the company is acquired, from the assets, to the working capital, inventory, customer lists and, yes, warranty obligations. The buyer steps into every single aspect of the company that faced the seller, including warranty obligations and existing lawsuits. For this reason, companies with large unsettled lawsuits or major warranty issues will likely find it impossible to sell stock. In an asset sale, clear title to only the assets of the company is delivered to the buyer. Warranty obligations, lawsuits and all liabilities stay with the selling corporate shell.
Customers will likely expect warranties to remain in force, particularly if the company continues to operate under the same brand name. Most door and window manufacturer acquisitions, though, are structured as asset purchases, giving the buyer the option of how to treat the warranty. In our experience, buyers that are not taking on the liability for warranties let key existing customers know about that fact even prior to the completion of the acquisition. That conversation usually includes the buyer letting the customer know that, while they are not accepting all warranty obligations, they will work with them if the dealer’s customers have any issues. This lets the buyer make decisions like not honoring the warranties of dealer customers that left the target company prior to the acquisition (or who leave afterward). The ability to selectively honor warranties can also become a source of leverage if a dealer is slow in paying.
The most critical aspect of warranty liability treatment in acquisitions is to over communicate how the warranties will be handled post-acquisition. If there are customers of the acquired company that were looking at other options prior to the acquisition, any uncertainty around warranty claims may cause them to leave. If handled properly, though, the treatment of warranty obligations can be a source of the first positive interactions between an acquirer and their new customers.