What are Reps and Warranties?
Representations (“Reps”) and Warranties are fundamental elements of a contract. Representations consist of statements regarding past or present facts made by one party at a specific moment in time, intended to induce reliance from the other party. Importantly, representations cannot pertain to future events. Warranties, on the other hand, are assurances provided by the maker of a statement, guaranteeing the truth of that statement. Unlike representations, warranties function as standalone promises, which include a commitment to compensate the other party for any damages if the statement is found to be untrue. Given that warranties are enforceable commitments, representations and warranties are typically paired together to ensure the enforceability of the statements made.
Reps and Warranties in the Context of Buying and Selling a Business
In the acquisition or sale of a business, representations and warranties serve as a remedy for the information asymmetry that exists between the parties involved. The buyer typically seeks assurance that they are receiving what they believe they are purchasing, prompting them to require representations and warranties from the seller for this purpose. Especially during the due diligence phase, these representations compel the seller to confirm to the buyer that there are no undisclosed issues. Representations and warranties foster transparency to mitigate information asymmetry between the parties and assign responsibility for any problems that may arise after the transaction is completed.
Common Seller Reps:
- The Company is duly incorporated, validly existing, in good standing, and is qualified to do business wherever required
- The company’s capital structure is as follows:
- The law does not prevent or limit, or require permission to do this deal
- Our financials are accurate
- The company’s SEC filings are accurate
- There have been no material adverse changes since our most recent financials
Common Buyer Reps:
- Buyer has corporate power and authorization to execute and perform the transaction
- Buyer has sufficient funds or committed financing to complete the purchase price payment
- Transaction will not violate any laws, regulations, or existing contractual obligations.
Flat vs. Qualified Reps
Representations and warranties can be categorized as either flat or qualified. Flat representations are straightforward and describe a condition as it is. For example: “the company is in compliance with all laws.” These flat representations offer the highest level of protection for buyers, as the seller assumes full liability in the event that any statement is false.
On the other hand, qualifiers introduce exceptions and nuances to the representations. The most common types are knowledge and materiality qualifiers. Knowledge qualifiers restrict the representation to the various levels of knowledge possessed by the individual or entity, asserting that they are unaware of any issues of the type described based on their actual or constructive knowledge.
Materiality qualifiers, meanwhile, limit the representation to cover only those conditions that are significant and differentiate between a material breach and a minor one. These qualifiers are often heavily negotiated within deals, as they can substantially constrain the scope of a representation or warranty.
Bring Downs
Since reps can only be made in the past or present tense, a buyer will want assurance that the reps are still true at the time of closing. Therefore, a seller should seek a bring-down condition in their closing conditions. A bringdown condition conditions closing on the target’s reps and warranties made at the date of signing the agreement, remaining true at the date of closing. A buyer may also request a bring-down certificate, which conditions closing on the seller delivering a certificate that the reps were correct when originally made and correct at the time of closing.
Breaches and Remedies
If a representation or warranty is breached before the closing, a party may have the option to withdraw from the transaction, choosing not to proceed with the sale or purchase. In such cases, there may be a substantial termination or reverse termination fee to compensate the other party for the time and resources they invested. Conversely, if a representation or warranty is breached after the closing, the primary remedy available is indemnification. Typically, the seller includes an indemnification clause, committing to reimburse the buyer for any damages that arise from a breach of these statements.
Conclusion
Representations and warranties are fundamental components of contracts that function as mechanisms for risk allocation in the buying or selling of a business. The parties involved can modify the scope of these provisions by adding qualifiers, which can significantly influence their exposure to liability. Additionally, bring-down conditions and indemnification clauses can safeguard the parties involved at both the conclusion of the deal and in the post-closing phase. Well-crafted representations and warranties can be pivotal in ensuring that a transaction proceeds smoothly, rather than leading to expensive disputes. Therefore, it is crucial not to overlook these essential provisions.
