Why the ‘Claims Threshold’ clause is the biggest secret of doing a deal
Lots of people, (some lawyers included…) have no idea why the small, unassuming ‘claims threshold’ clause that’s usually found somewhere near the end of their deal agreement is worth spending any real time on.
But, successful deal makers know that a strong ‘Claims Threshold’ clause is probably the single biggest secret to coming away with a great deal.
So what is a ‘claims threshold’ clause, and why is it the greatest secret in the world of business sales?
In order to explain what’s really going on here, let me give you some background.
Deals can go ‘wrong’ for a lot of reasons, but the main problems occur when:
1)The business isn’t actually’t what it was made out to be by the Seller; or
2) There were skeletons hiding in the closet, such as unpaid debts; or
3) A bunch of undisclosed or unknown liabilities start popping up, that the Buyer was never told about.
When these sorts of things happen, then the Buyer may try to bring a claim against the Seller, to recover their unexpected losses.
Lawyers can often spend a lot of hours (and a lot of your money) trying to create Warranties to protect the Buyer’s interests. But there’sa section in the Sale and Purchase agreement (SPA) which contains a number of clauses that deal with the circumstances in which a Buyer is able to bring a claim against the Seller. The most crucial of those clauses is our ‘claims threshold’ clause.
This clause sets the financial limit which must be reached before a claim can be brought.
For example, a claims threshold clause may say: “No claim may be made under the SPA unless each individual claim is worth a minimum of £5,000, and together not less than £20,000”.
Let me explain what this clause is actually saying, in plain English.
Firstly, it’s saying that if there are a number of problems with the business, but each individual problem doesn’t result in a loss of at least £5,000, then the Buyer can’t make any claim against the Seller.. Secondly, it’s staying that even if the Buyer has a claim worth more than £5,000, if they don’t have a number of claims that are worth at least £20,000, then again, they don’t have a legal leg to stand on when it comes to trying to get that money back from the Seller..
Now, the claims threshold is a negotiable figure (the £5,000 and £20,000 I used above are just examples). So, if the Seller manages to set this threshold high, he can wipe away 90% of all potential claims ever arising under an SPA. If the Buyer can set it low, then he’s got a much better chance of being able to reclaim his losses if something goes wrong.)
Let’s summarise what you’ve just learnt, as it’s potentially one of the most crucially important bits of information in the entire deal.
If a Seller places the bar high enough on the claims threshold clause, they can coast through the rest of the agreement, and not get sucked into hours of expensive legal wrangling about ‘Warranties’, which could never actually amount to that level of loss.
On the other side of the coin, an unsuspecting Buyer can end up with a whole load of warranty claims he can never actually bring against the Seller, unless they’ve made sure that the claims threshold clause is set at a low enough level to make it workable.
Knowing this can save a Seller a lot of time, money and energy in drafting the agreement and save the Buyer a lot of unrecoverable losses further down the road.
That’s why the ‘claims threshold’ clause is definitely a secret worth knowing, whichever side of the deal you happen to be on.