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Limit Your Exposure In a Sale

Many people think that when they sell a portfolio of merchants they can take the cash and not worry about the future performance of the portfolio. But that is far from being true. Because the seller is making numerous representations and warranties about the portfolio, the seller can have considerable exposure in the future. This article will seek to define that exposure and give you tips on how to minimize it.

Where is the exposure?

In a typical agreement for the sale of a portfolio of merchants, the triggering points that determine the potential future liability of the seller is governed by what is called the “representations and warranties” section of the portfolio purchase agreement. That section of the agreement has a number of provisions that are essentially statements by the seller about various attributes of the portfolio. For instance, such provisions can say things such as “there are no sales agents that are entitled to any portion of the residuals that are being sold”; “there are no merchants that have threatened to terminate their merchant agreements”; “there is no pending or threatened litigations that would affect the portfolio”; and that “the seller has complied with all applicable laws and card association rules.”

These statements about the portfolio do not serve to subject the seller to liability on their own. The liability arises from the fact that these representations and warranties are linked to the indemnity provisions in the portfolio purchase agreement.

The indemnity provisions serve to make the seller liable to the purchaser under certain circumstances if the purchaser suffers damages. So, the indemnity provisions will invariable state that if any of the representations and warranties are not true, that the seller will have to indemnify and hold harmless the purchaser for any damages that are suffered by the purchaser.

To translate that into English; say for instance the seller represents and warrants that none of the merchants in the portfolio that is being sold have threatened to terminate their merchant agreements. So the sale is completed and then a month after the deal closes the largest merchant in the portfolio closes its account, causing the portfolio to lose 10% of its monthly income. The purchaser looks in the merchant’s file and lo and behold finds out that the merchant, months before the sale went through, had said it was going to cancel the account. Because the seller knew that merchant was going to terminate, and arguably failed to disclose that fact to the purchaser, now the seller will be forced to pay back the purchaser 10% of the sale price that had previously been paid to the seller.

How to Minimize Your Exposure:

So how does a seller minimize their potential liability under a portfolio purchase agreement for a breach of the representations and warranties? One way is to make sure that you disclose anything that could cause such a breach. As part of the sale process, disclosure schedules are prepared that set forth all the exceptions to the representations and warranties. For instance, if there is a lawsuit pending or threatened against the seller this should be disclosed to the purchaser. The purchaser may agree to be liable for defending the lawsuit if it is a common part of the operation of the business or the parties can adjust the purchase price to account for such a risk. This may be a simple way for the seller to minimize their potential exposure for such issues.

Another way is what is called a “basket” on the indemnity issues. If there are smaller claims, a seller is not going to want to have the burden of paying and having to deal with all these small claims that are not really substantive. So the seller and purchaser agree that the indemnity obligations must reach a certain threshold before the purchaser can ask for reimbursement for any indemnity claims. Once that threshold is reached, the seller still owes for all the claims that have been made, just those not above the threshold. But if you negotiate a high threshold, it could serve to save you from the expense and waste of time in having to deal with some minor claims.

The best way to limit your potential liability is by way of a “cap” on your possible obligations as a seller for any breach of the representations and warranties. Without a cap, arguably you could be liable to the purchaser for more than the amount that you are paid for the portfolio. Instead, a cap sets a maximum amount that you can ask to pay to the purchaser in regard to any indemnity.

Most of the time the cap is stated as a percentage of the total purchase price that is paid to the seller. For instance, if a seller is paid $10 million for a portfolio, I typically start out by saying that the seller would like to cap its potential liability at 25% of the purchase price which would be $2.5 million. This way if something goes awry with the portfolio in a big way, then the seller is guaranteed at least to keep a part of the purchase price. What percentage actually makes it into the portfolio purchase agreement is usually one of the most contentious issues in these types of negotiations.

In the portfolio purchase process, understanding that the close of the sale is not the end of the exposure to the seller is important. Sellers must seek to minimize their liability for breach of the representations and warranties or there could be a large bill to pay in the end.

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