In share purchase agreements (“SPA”), the parties may provide for contractual provisions that exclude or limit the seller’s liability to a certain extent. In practice, such limiting provisions are quite common, as the balanced distribution of risk in acquisition transactions is one of the parties’ fundamental priorities.
However, with respect to certain matters — particularly subjective qualifications and the representations and warranties falling within this scope — a complete exclusion of liability is not possible. Moreover, where the seller is grossly at fault for transferring the business with defects, any contractual provisions that exclude or limit liability are deemed null and void pursuant to Article 221 of the Turkish Code of Obligations No. 6098 (“TCO”).
Exclusion or Limitation of Liability by Contract
SPAs are, by their nature, instruments largely based on the principle of freedom of contract, allowing the parties to determine how risks will be allocated between them. Within this framework, the provisions of the TCO governing the seller’s liability for defects operate as reserve provisions. Accordingly, unless otherwise stipulated by law, the parties may expand, limit, or even entirely exclude the seller’s liability. Such provisions are frequently used in practice.
Instead of entirely excluding the seller’s liability, the parties may also prefer to narrow it within certain boundaries. For instance, while the seller undertakes that in the target company certain favorable qualities exist or that certain adverse circumstances do not exist, the parties may limit the seller’s liability regarding such representations and warranties in terms of duration, amount, or scope. In this case, the buyer may exercise its rights arising from defects only within those agreed limits. In practice, such arrangements are commonly referred to as “non-liability agreements”.
However, it should be noted that these limitations are not legally valid in cases where the seller is grossly negligent. Pursuant to Article 221 of the TCO, if the seller is grossly at fault in transferring the business with defects, the buyer may assert its statutory remedies arising from defects irrespective of the contractual limitations.
Clauses Limiting Liability in SPAs
Provisions limiting the seller’s liability in SPAs constitute one of the most critical subjects of negotiation between the parties. While the buyer seeks to define the seller’s liability as broadly as possible in order to secure its position, the seller aims to confine the scope of such liability within certain limits and to avoid being held responsible in every conceivable circumstance. For this reason, share sale agreements contain detailed provisions that the parties work meticulously on to establish this balance. Under this heading, we will address the clauses most frequently encountered in practice.
a. Disclosure Letter
Under the general disclosure approach, which originates from Anglo-Saxon legal systems, the broad set of documents provided by the seller to the buyer is deemed to place the buyer on notice of the information contained therein. Thus, the seller is relieved of liability to the extent of the information provided to the buyer. However, in transactions where the target company’s operations carry risk and the documents are numerous and scattered, this method can create significant risks for the buyer. Therefore, in practice, all matters for which the seller’s liability is waived are clearly stated in a disclosure letter. Thus, the seller is only released from liability for the disclosed matters, while liability continues for matters not disclosed.
In practice, the disclosure letter — commonly attached as an exhibit to the SPA — is most often delivered to the buyer in draft form shortly before signing. The letter includes the matters disclosed by the seller to the buyer and the exceptions to the representations and warranties contained in the agreement. These disclosures may cover both deviations from the contractual wording and findings revealed during the due diligence process.
From the seller’s perspective, the disclosure letter serves as a tool confirming that all information and documents contained therein are known to and accepted by the buyer. The ultimate purpose is to prevent future claims of breach of representations and warranties; since the buyer is deemed to have become aware of the disclosed matters, the seller should not be held liable for them at a later stage.
However, circumstances referred to in the disclosure letter may change between signing and closing. Therefore, the parties should expressly regulate this possibility in the agreement. For example, the agreement should clarify whether the seller will have the right to update the disclosure letter at closing, and which party will bear the risks arising from any such changes.
b. Knowledge Qualifier
The knowledge qualifier, which is frequently used in SPAs, is an important mechanism limiting the seller’s liability. Although, pursuant to Article 219 of the TCO, the seller’s liability for defects is not dependent on their “knowledge” of the defect, in practice, contracts often limit the seller’s liability to defects that they knew or should have known.
Such qualifiers are particularly significant in relation to matters that the seller cannot reasonably verify directly. For example, representations that there are no pending or threatened lawsuits or arbitration proceedings against the target company, or broader undertakings outside the seller’s direct control, are often linked to the seller’s knowledge.
However, it should be noted that this criterion does not apply to matters that the seller was unaware of due to gross negligence but could have known had they exercised due diligence and conducted the necessary investigation into the target company. In such cases, the seller’s liability continues.
Another point of debate concerns whose knowledge will be taken into account. In this respect, expressly identifying the relevant individuals or their positions within the company in the contractual clause will work to the seller’s advantage. Otherwise, while the seller aims for limited liability based on their personal knowledge, they may face the risk of a broad interpretation requiring the information of the target company’s management and the seller’s financial and legal advisors, who are involved in the process, to be taken into account.
c. Materiality Qualifier
Another commonly used method of limiting liability in SPAs is the materiality qualifier. Under this approach, the seller is held liable only for breaches that are significant or financially meaningful. In this way, the seller is not exposed to liability for minor discrepancies or breaches that do not materially affect the company’s operations.
The materiality criterion is generally determined based on a monetary threshold or an impact-based definition. For example, only damages above a certain amount or errors that significantly affect the financial statements are included in this scope. In this way, the parties aim to prevent minor differences or technical breaches from leading to post-contractual disputes. However, an ambiguous definition of “materiality” may lead to differing interpretations between the parties in the future. Therefore, it is crucial that the materiality threshold is defined in the agreement in a clear, measurable, and objective manner.
In conclusion, while the materiality qualifier is an effective tool for balancing risk allocation between the parties, the circumstances in which it applies, how the thresholds are determined, and how it interacts with other limitation mechanisms should be clearly regulated in the agreement.
d. Monetary Limitations
Another common method of limiting the seller’s liability in SPAs is the use of monetary limitations. These provisions aim to cap the compensation that may arise from breaches of the seller’s representations and warranties at a certain amount, thereby protecting the seller from being exposed to liability for minor or insignificant breaches. This amount is typically determined as a percentage of the purchase price, although the parties may also agree on a fixed amount.
In practice, not only an overall liability cap, but also certain monetary thresholds are introduced. The first of these is the de-minimis rule, which sets a minimum amount for each individual loss. Under this rule, the buyer may bring a claim against the seller only if the claim exceeds the specified minimum amount. The second is the basket mechanism, which provides that no claim may be brought unless and until the aggregate losses arising from breaches of the SPA reach a certain level. This mechanism may be structured in two different ways: the seller may be liable either for the entire amount of the buyer’s claim once the threshold is exceeded, or only for the portion exceeding the basket amount.
e. Time Limitations
Limiting the seller’s liability to a specific period is another one of the most commonly used mechanisms in SPAs. These provisions stipulate that claims arising from the seller’s representations and warranties may only be brought within a certain period of time. In this way, the seller is protected from uncertainties that may arise many years after closing, and greater predictability is ensured in the post-closing period. However, these periods must be determined in a reasonable and proportionate manner; otherwise, excessively short limitation periods may produce outcomes that unfairly disadvantage the buyer.
In practice, such periods are generally set between 12 – 24 months, although they may vary depending on the content and subject matter of the relevant representation or warranty. This allows each type of risk to be limited within a time frame appropriate to its nature. For example, representations and warranties relating to title to the shares are often subject to the general 10-year statute of limitations, while tax-related liabilities may be subject to a 5-year period, and other representations and warranties may be limited to significantly shorter durations.
On the other hand, where a representation or warranty qualifies as a guarantee undertaking, any claims the buyer may assert against the seller are subject to a 10-year statute of limitations under Article 148 of the TCO, and this period may not be contractually shortened. Therefore, contractual time limitations should be regarded not as provisions shortening the statute of limitations, but rather as technical mechanisms defining the period during which the seller bears the relevant risk. Accordingly, even if the contractual period expires, the buyer may still pursue a claim against the seller, provided that the risk has materialised within the agreed period and the buyer has complied with its contractual obligations (such as notifying the breach in a timely manner).
For a deeper understanding of how these mechanisms are structured in practice and tailored to complex transactions, you may explore ANKA Law’s Corporate Law services, where such risk-allocation issues are addressed comprehensively within the broader framework of M&A and commercial advisory.