Term and Legal Classification of Warranties
The Term Warranties (in German: guarantees or assurances) is a central term in the law of obligations, particularly playing a significant role in international commercial law and Common Law. Warranties are contractual assurances or guarantees that one party gives to another within a contract. Their purpose is to guarantee certain features, conditions, or circumstances of the subject matter of the contract or about the parties themselves. Warranties are relevant both in civil law and commercial law and differ substantially from other types of legal assurances such as representations, covenants, and conditions.
Legal Systematic Foundations of Warranties
Warranties in Common Law
In the Common Law system, particularly in the United States, United Kingdom, Australia, and Canada, a “warranty” refers to a contractual or statutory ancillary obligation that does not constitute a “condition” under contract law. The breach of a warranty generally gives rise to a claim for damages, but, in contrast to the breach of a condition, does not normally result in the termination or rescission of the contract.
English contract law distinguishes between two essential contractual duties:
- Conditions: Core contractual obligations, the breach of which (“Breach of Condition”) may grant a right of termination (“Right of Termination”).
- Warranties: Ancillary duties, the breach of which ordinarily results in a liability for damages, but not a right of termination.
Warranties in German Law
There is no exact terminological equivalent to “warranty” in German law. The terms “Garantie” (guarantee) or “Gewährleistung” (warranty/liability for defects) are used, but differ in substance:
- Gewährleistung governs the statutory rights of the buyer in case of defects in the purchased item, as per §§ 434 ff. BGB.
- Garantie is a voluntary, additional commitment by the seller or manufacturer that goes beyond the statutory warranty (§ 443 BGB).
In the context of international contracts or when using English-language contract templates, the terms should be clarified as precisely as possible to avoid misunderstandings and differing legal consequences.
Types and Structure of Warranties
Contractual Warranties
Contractual warranties are regularly explicitly agreed upon in contracts. They may relate to various aspects, such as:
- Freedom from encumbrances (no encumbrances)
- Compliance with specifications
- Existence of rights and licenses
- Accuracy of balance sheets
- Compliance with tax and regulatory obligations
In the context of share purchase agreements and asset deals, warranties are of particular importance. Here, they serve as a key instrument for risk allocation between the contractual parties.
Statutory Warranties
In addition to contractual warranties, many legal systems provide for statutory guarantees. Examples can be found in consumer protection law, where certain quality and functionality guarantees are required. In German law, this corresponds to the statutory liability for defects under the German Civil Code.
Difference Between Warranties, Representations, and Covenants
- Warranties: Assure certain characteristics and give rise to claims for damages in the event of inaccuracy.
- Representations: Are pre-contractual assurances; their inaccuracy may result in rights of rescission or reversal of contract.
- Covenants: Obligate to perform or refrain from certain future actions.
This distinction is especially important in international contracts, because the choice of terms entails different legal consequences.
Legal Consequences of Breaching Warranties
Damages
If a warranty is breached, there is generally a claim for damages. The aim is to place the disadvantaged party in the position they would have been in if the warranty had been correct.
Limitation of Liability and Enforcement
In practice, warranties are often limited by so-called “disclosures.” Here, certain known risks are disclosed to the buyer for which no liability is assumed. In addition, liability caps, minimum thresholds (“De Minimis”), and limitation periods (“Time Limits”) are agreed upon. These restrictions serve to minimize risk and provide planning certainty for both parties.
Rescission and Termination of Contract
A breach of warranty only entitles the party to withdraw from the contract in exceptional cases. The right to withdraw typically exists only in the case of a breach of conditions or in the event of a material breach.
Practical Importance and Fields of Application of Warranties
Company Acquisitions and M&A Transactions
Warranties play an outstanding role in the context of company acquisitions and mergers. They are used to reveal hidden risks and clearly assign responsibility for certain matters. Typical warranties concern company figures, liabilities, contractual relationships, legal disputes, and compliance topics.
Sales Law
In sales law, especially in commercial transactions, warranties secure the characteristics of the object of purchase. In international sales of goods governed by the CISG, the system is more similar to the German warranty regime, but the terminology of warranties is also used.
Project Law and Distribution Agreements
Warranties are also regularly agreed upon in project-based contracts such as construction agreements, license agreements, or distribution agreements in order to assure certain performance or condition characteristics.
Summary
Warranties are legally relevant assurances in contract law, playing a central role especially in international commercial transactions. They differ from other contractual obligations due to their limited set of legal consequences and serve to allocate risk and provide transparency in contract formation. The exact definition and legal structuring depend largely on the respective legal system, which is why careful contract drafting and precise definition of terms are required.
References
- Palandt, Bürgerliches Gesetzbuch, current edition (commentary on § 443 BGB)
- Müller, Gewährleistung und Garantie im Kaufrecht, NJW 2017, 1642
- Duden, Legal Dictionary, entry “Garantie”
- Benjamin’s Sale of Goods, 10th Edition (English law)
- Schwenzer/Hachem/Kee, Global Sales and Contract Law, 2nd Edition
Frequently Asked Questions
What claims exist in case of breach of warranties?
If a warranty, i.e. a contractually agreed assurance or guarantee, is breached, the contracting partner is generally entitled to claims for damages. Unlike so-called “conditions”, a breach of warranty does not usually result in termination of the contract, but is limited to compensation for the damage incurred. The aggrieved party must demonstrate and prove that a specific damage has been caused to them by the breach of warranty. The amount of compensation is determined by the so-called “expectation damages” principle: the claimant is to be put in the position they would have been in if the contract had been properly fulfilled. It should be noted that contractual limitations of liability often apply, and liability for indirect damages may be contractually excluded. Warranty claims are also regularly governed by contractual limitation periods, which may be shorter than the statutory limitation period.
What is the relationship between warranties and statutory warranty rights?
Warranties are purely contractual assurances and thus generally exist alongside statutory warranty rights. While statutory rights such as those under § 437 BGB apply in cases of material or legal defects and form mandatory law, warranties are based on an individual agreement between the parties. In international contracts, especially in Anglo-American jurisdictions, warranties are more significant than in German law because they can cover specific risks through individually tailored provisions. Often, statutory warranty rights are excluded or limited in the contract by so-called “entire agreement” or “exclusion clauses”, making the contractual warranties the sole basis for claims.
What are the differences between “warranties” and “representations”?
“Warranties” and “representations” are both contractual assurances, but differ fundamentally in their scope of liability and legal treatment. A “representation” in Anglo-American law is a statement of fact made by a party before the contract is concluded. If it is given falsely or misleadingly, it can give rise to pre-contractual liability (misrepresentation) and may entitle the other party to rescind the contract. In contrast, “warranties” are independent assurances within the contract, the breach of which entitles the party to damages, but not to rescission or, as a rule, to termination of the contract. Therefore, in contracts, especially those in English, it is essential to carefully define how and with what legal consequences individual assurances are formulated.
How are warranties regulated in M&A agreements?
In M&A transactions (Mergers & Acquisitions), warranties play a central role. The seller gives numerous warranties, for example regarding the accuracy of annual financial statements, proper payment of taxes, or the existence of material contracts. The purpose of the warranties is to provide the buyer with the most comprehensive protection possible against previously unknown risks. The scope, content, and duration of the warranties are individually negotiated: it is common to have a specific list of all relevant topics, and for certain warranties (e.g., tax or environmental warranties), extended liability periods may be agreed upon. M&A agreements often also stipulate liability caps or thresholds for warranty claims in order to make the seller’s liability calculable.
Can warranties be excluded or restricted?
In principle, the parties are free to exclude warranties in whole or in part or to restrict their content. In commercial transactions, neither German nor international contract law prescribes mandatory minimum standards for warranties. However, general restrictions may be invalid under the law governing general terms and conditions (§§ 305 ff. BGB) if they are surprising, unreasonably disadvantageous, or intransparent. Moreover, liability for intent or fraudulent misrepresentation generally remains unaffected; contractual exclusions of liability do not usually apply in cases of intent (§ 276 (3) BGB). In consumer contracts, exclusions are also frequently restricted by law.
What is the significance of knowledge qualifiers in warranties?
In connection with warranties, so-called “knowledge qualifiers” are widespread. This means that the scope of a warranty is tied to the actual or hypothetical knowledge (“knowledge”) of the seller or another person. In practice, this means that a warranty applies not absolutely, but only to the extent of what the seller knew or should have known through negligence at the time of conclusion of the contract. The precise standard (“actual knowledge”, “constructive knowledge”, “best knowledge”) should be clearly defined in the contract. This has a substantial impact on the enforceability of claims, as in the event of a dispute, the buyer must substantiate that the fact within the area of knowledge was known to the seller or should have been known.
How long can claims arising from warranties be asserted?
The assertion of claims arising from warranties is usually limited by contractually agreed periods. These liability periods vary greatly depending on the subject matter of the contract and the individual negotiation result. While general warranties are often subject to periods between 12 and 24 months from contract conclusion, special warranties—such as those relating to taxes or the environment—may be governed by considerably longer periods, up to five or even seven years. If no specific agreement is made, the general statutory limitation periods apply, usually three years from knowledge of the claim according to § 195, § 199 BGB. It is also important that the commencement and expiry of the period are defined precisely in order to prevent disputes.
What should be considered when using warranties internationally?
When using warranties in cross-border contracts, it is of particular importance to make a choice of law and adapt to the respective national law. Countries such as the United Kingdom, the USA, or other common law countries have different scopes and legal consequences of a warranty than German or continental European law. In particular, Anglo-American law clearly distinguishes between “representations”, “warranties” and “indemnities”. The question of enforceability, for example before courts in one party’s home country, also depends on the chosen law and jurisdiction. Therefore, parties should seek legal advice to clarify which legal effects the agreed warranties will actually have in the respective contractual context.
