What Are Representations and Warranties?
Representations and warranties are a critical and integral component of business transaction agreements and can vary significantly based upon the type and complexity of the deal. While there are a variety of names for these transactional documents, the most common terms are: Asset Purchase Agreements (APA), Definitive Purchase Agreements (DPA) and Purchase & Sale Agreements (PSA). Reps and Warranties should be carefully considered and customized to the specific transaction to ensure they accomplish the objectives of each party.
Representation: A representation is defined by Black's Law Dictionary as "A presentation of fact -- either by words or by conduct -- made to induce someone to act, especially to enter into a contract." While both buyers and sellers make representations and warranties in a transaction document, the seller's representations generally comprise the largest component. A seller will make representations, as assurances to the buyer, that involve a litany of financial, legal, and operational issues pertaining to the business being sold, from both the past and present. Buyers' representations generally revolve around acquisition financing as they may be required to provide assurances that financing commitments are firm and that they are capable of satisfying a cash payment at closing. In very limited situations there exist circumstances where a representation has a "knowledge" qualifier, meaning that the seller is only responsible for a breach if it was known that the representation was false.
Warranty: Whereas, a representation is a statement of a present or past fact at the time the representation is made, a warranty is a promise extending into the future, typically beyond the purchase contract phase. The distinction between representations and warranties has lost some relevance as most acquisition agreements will use these two terms in tandem. Using the terms "representations" and "warranties" together blends the past, present and future within the contract. In most cases, especially for small business acquisitions, a buyer and seller sign an agreement in which they "represent and warrant" a variety of statements - some past, some present, and some future, without clarifying which of these are representations and which are warranties.
Representations and Warranties serve several important purposes: In most agreements, one party is relying on specific data from another party, all of which might not be available through due diligence. These representations and warranties become a useful device to obtain disclosure of critical information about the business. Representations and warranties create a basis for either a delay in closing or a termination of the deal, should subsequent due diligence uncover inconsistent or false information before closing. The representations and warranties provide the framework for the seller's indemnification obligations to the purchaser after a transaction closing. Breaches of representations and warranties form the basis for indemnification claims where the buyer is able to seek compensation for any damages incurred.
While the boiler plate provisions for standard agreements are too numerous to discuss here, listed below are the more common representation and warranties: Corporate Organization- Business was properly formed and has the necessary licenses and authority to operate. Authorization / Valid & Binding- Corporate resolution and/or all other internal approvals (owners/board of directors/shareholders) documenting that the sale has been authorized. Financial Statements - Assurance that the financial statements provided to the buyer are accurate and complete in all material aspects. Assets/Liabilities- Detailed listing of what assets are included in the transaction and assurances that the seller has good, valid, and marketable title. Additionally, an outline of the specific liabilities that are being assumed by the buyer and assurances that there are no undisclosed liabilities or obligations (typically for stock sales).
Compliance with Laws/Litigation- Business is not in violation of any state, federal, or local law. Additionally, there is no pending or threatened litigation. Taxes - Lists any tax liabilities and assures the buyer that all tax obligations have been paid or properly reserved for. Employee Benefits- Lists any HR issues related to employment laws, potential litigation, and unfunded pension liabilities. Environmental- Indicates that the seller has complied with all environmental laws and regulations and discloses any issues the business has had in the past (e.g. hazardous materials). This is pertinent when real property is involved. Contracts- List of the material agreements and contracts with vendors, manufacturers, or clients and certifies that they are valid & enforceable and confirms that the seller is not in breach of any of them.
Regardless of the size or structure of a business acquisition, the purchase agreements will involve a number of representations and warranties that provide each party with essential assurances on the nature, scope, and particulars of the deal. Representations and warranties are critical sections of the agreement, often involving considerable negotiation between parties, and it is highly recommended to involve an attorney early in the process who is skilled in drafting purchase agreements for the particular industry and size of transaction being considered. Both buyers and sellers should give considerable thought to the representations and warranties that are essential to them and communicate these to the other party. This ensures that they are properly reflected in the transaction document, thereby avoiding unpleasant surprises, costly time delays and considerable unexpected expenses.
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