Reps and Warranties in a Sale and Purchase Transaction

Reps and Warranties in a Sale and Purchase Transaction

In the world of mergers and acquisitions (M&A), Reps and Warranties (R&W) clauses play a key role in managing the risks and liabilities of both parties to the transaction. These contractual R&Ws relate to the truthfulness of the information provided by the seller about the company or assets being sold. 

Reps and warranties are representations of past or present facts made by the seller in a sales contract. Their purpose is to assure the buyer that the information provided about the company or assets that are the subject of the transaction is true and accurate. In this context, Representations are statements of facts or circumstances that already exist, whereas Warranties are guarantees that these facts are true and will be maintained for a certain period of time.

These clauses cover crucial aspects of the business, such as financial condition, ownership of assets, key contracts, regulatory compliance, intellectual property and litigation. In essence, R&Ws are a way of shifting some of the risk of the transaction from the buyer to the seller.

The main purpose of reps and warranties is to mitigate the risk inherent in any M&A transaction. These clauses are essential for the buyer to have certainty about what he is acquiring and about the actual state of the company in question. They therefore serve as a protective tool that provides certainty to the buying party, as the seller is obliged to indemnify if any of its representations turn out to be false or inaccurate.

For example, in a sale and purchase, if the seller assures that the company has no pending litigation and it turns out that this statement is incorrect, the buyer could claim compensation for damages resulting from this inaccuracy. In this sense, R&Ws not only provide legal certainty, but also act as a price adjustment mechanism if discrepancies arise after the closing of the transaction.

Representations are statements about the status of the company, such as the possession of necessary licences or the accuracy of its financial statements. For example, the seller might state that the company has all the necessary licenses to operate or that the financial statements provided accurately reflect the company’s financial condition.

The warranties, on the other hand, guarantee that these statements are true and, if they are not, the seller assumes liability and must compensate the buyer for any loss or damage arising from such inaccuracies. Warranties are therefore a commitment by the seller as to the accuracy of the representations.

R&Ws are vital to the success of an M&A transaction, as they establish a legal framework that protects both parties and allocates risks fairly. For buyers, these clauses ensure that the company they are acquiring has no hidden surprises that could adversely affect the deal. For sellers, on the other hand, it is crucial to limit the scope and duration of these warranties to avoid future disproportionate claims.

One of the most delicate parts of R&W is its negotiation, as both parties try to limit their risks. Typically, time and quantitative limits are set for the guarantees. Time limits usually specify a period during which the buyer can claim compensation, while quantitative limits fix the maximum amount of the seller’s liability. These restrictions protect the seller from claims that are indefinite in time or of a disproportionate magnitude.

It is also common for parties to include specific compensation mechanisms, known as indemnities, which are additional commitments to cover risks identified during due diligence, such as ongoing litigation or environmental issues.

Failure to comply with Reps and Warranties can have serious consequences for the seller. If any of the representations are incorrect or false, the buyer has the right to claim compensation or even to declare the contract null and void, depending on the seriousness of the situation. Compensation for non-performance is usually linked to the economic damage suffered by the buyer, but may also include other contractual remedies, such as adjustment of the purchase price or termination of the agreement.

In practice, however, R&W disputes are less common than one might think, as both parties usually invest time and resources in carefully negotiating and drafting these clauses to avoid future disputes and minimise potential risks.