Types of representations and warranties in M&A

The Jack Pine - Tom Thomson's

Para la version en castellano ir a este link.

We have seen what are representations and warranties in previous entries of this blog, such as in: Link 1, Link 2, Link 3 and Link 4 (all of them in Spanish).

With this entry we will highlight the four main types of representations and warranties usually included in company’s purchase agreements (M&A transactions). Although representations and warranties exist and are usually used both by the buyer and the seller, the most relevant of them are, by far, those made by the seller. Therefore, now we will focus only on representations and warranties made by the vendor party. In case of distress M&A representations and warranties made by the buyer become more relevant, but this is not our current purpose to remark particularities applicable to distress M&A transactions. In this entry there are some comments regarding distress M&A, available only in Catalan and Spanish.

1) Declarations of the seller referred to the existence and subsistence of past and/or current events.

This type of declarations are used by the seller to descibe the object of the sale, so that the buyer cannot subsequently claim for absence or defect in the consent. Therefore, if certain facts stated are proved non-existent, incorrect or false, the agreed consequences against the issuer.

Among this kind of representations and warranties we can find, for example: statements on the performance of certain environmental controls in the company’s facilities, the correct registration of certain IP rights, the proper functioning of certain software developed by the company, etc.

2) Declarations of the seller referred to future events.

This type of declarations are used to force the seller acting in certain way, or to ensure that certain result is given, and for which the seller, therefore, must make its best efforts to create or promote the result.

Among this kind of representations and warranties we can find, for example: register certain rights of the company, finish to develop certain products, continue investing in certain project, etc.

As a general rule, and without prejudice to the need of regulating the consequences of non-compliance with these statements, in case such future results do not occur, the seller must indemnify the buyer, unless the latter proves the existence of a reason that exonerates from liability. In addition, certain non-compliance may even lead to nullity of the purchase agreement. However, such an extreme consequence should be expressly contemplated, as it needs to be considered as an essential element of the contract linked to this nullity effect.

3) Declarations of the seller referred to possible or expected future events.

This type of declarations are used for future events in which the seller cannot ensure its compliance. This is, it is referred to future events that responds to seller’s beliefs and that, even in case the seller make its best efforts, such event may not occur. Consequently, non-compliance of declarations of this type must have lower harmful consequences for the seller. In this case the most common consequence is an adjustment of price, and rarely a penalty clause or nullity of the agreement. Additionally, such harmful consequences for the seller should apply only in case declarations were false or negligent at the time them have been issued. Therefore, if them were issued in good faith it would not be considered a sellers breach of contract.

Among this kind of representations and warranties we can find, for example: statements on no foresight of future penalties due to environmental subjects, certain forecast of turnover, the execution of certain commercial agreement or agreements with third parties, etc.

4) Declarations of the seller referred to the characteristics and consequences of its declarations.

This last kind of representations and warranties is especially relevant, because non-compliance of representations and warranties may have no effect against its issuer if its consequences are not expressly provided for. Therefore, the parties must identify which representations and warranties are binding and which are not, and also what are the consequences of non-compliance regarding each and every declaration made.

In case the consequences are not regulated, the parties and the judge may not be able to define the relevance of the breach and its compensation, adjustments or even if it may result in entire nullity of the agreement. Therefore, it is especially relevant to identify the most and less relevant declarations.

In essence, this last kind of representation and warranties provide the rules applicable to the representations and warranties themselves.