What is a representation and warranty that is given by the parties in connection with an acquisition?
In a share purchase agreement or an asset purchase agreement, the seller gives the buyer various representations and warranties concerning the target company, the business, and the conduct of the business of the target company before the date of the acquisition. These seller’s representations and warranties are promises to the buyer about the current state of the business of the target company and also promises, that the seller believes that the business of the target company can continue as it is at the date of the transaction for a certain period of time after the date of completion of the transaction. If the seller has made representations and warranties at the time of the transaction which later prove to be incorrect, this may result in the seller being liable for damages to the buyer when the object of the transaction does not correspond to what the buyer was represented in the transaction.
Whether it’s a share or business purchase, the seller’s representations and warranties often form a significant part of the share purchase or business purchase agreement. Although the seller’s representations and warranties are largely in standard form in many transaction agreements, the seller must pay close attention to them to ensure that they can be provided in this particular transaction. The buyer will conduct due diligence on the target company prior to the transaction to familiarise itself with the company, but ultimately it is the seller who has the most information on the target company and the company’s business, and it is therefore the seller’s responsibility to ensure that the representations and warranties in the agreement are correct and accurate.
The wording of the representations and warranties in the transaction agreement can influence whether the transaction agreement is more buyer- or seller-friendly. Broadly and loosely worded seller’s representations and warranties are more favourable to the buyer, while precise and specific seller’s representations and warranties protect the seller’s interest. The buyer expects the seller to be liable for any misrepresentations made in the transaction agreement, and it is therefore in the seller’s interest to seek the most precise delineation and definition of the representations and warranties. On the other hand, more extensive representations and warranties of the seller on the object of sale also give the buyer more security for the future operation of the business, which in turn may have a positive effect on the purchase price the buyer is willing to pay.
Although the seller’s representations and warranties are generally in standard form, the characteristics of the transaction have an impact on the types of representations and warranties that sellers give in connection with the transaction. The content of the representations and warranties may be influenced by the type of transaction, the transaction price, any findings that have been made in the due diligence, and general market practices in the business sector being acquired. It is therefore important that the seller carefully consider the representations and warranties it will give to the buyer in the sale and purchase agreement before signing it. If the seller is aware of any matters in respect of which the seller cannot provide a particular representation, these matters will normally be added as enclosures in the sale and purchase agreement and referred to as “save for enclosure XX”. Such circumstances may include, for example, a pending lawsuit against the company or an agreement that contains a termination clause for another party to the agreement in the event of a transaction. These matters will normally also come to the buyer’s attention during the buyer’s due diligence and will therefore be known to the buyer, but in any event, the seller is advised to “flag” such matters of which the seller may be aware when drawing up the agreement and giving representations and warranties for the object of the transaction.
Here are some examples of sellers’ representations and warranties that are usually included in the acquisition agreements:
Sellers’ authority and title
In the transaction agreement, the sellers represent and warrant firstly that they have title to the object of sale and that the object of sale is free from encumbrances for the purposes of the sale. In case the transaction is a share purchase, this representation is given by the shareholders of the target company, who assure that they own the shares in the company and that the shares are free of encumbrances and can therefore be freely transferred to the buyer in the sale. In the case of a business purchase, this representation and warranty are given by the company that owns the business that is sold.
The sellers also represent and warrant that the target company is duly registered and that it has the authority and necessary permits to conduct the business of the company. In addition, the sellers will normally also represent and warrant that the company is not insolvent and that there are no bankruptcy, repossession, liquidation, reorganization, or similar proceedings pending against the company and that there are no other arrangements with the company’s creditors.
Accounting, financial statements and taxes
The usual seller’s representations and warranties include a declaration by the seller that the company’s accounts have been kept in accordance with good accounting practices and that the company’s accounts are up to date. In addition, sellers generally represent and warrant that the company’s financial statements are properly prepared and give a true and fair view of the company’s profit or loss, financial position, assets, liabilities and contingent liabilities on the account’s date. This representation and warranty is usually given for financial statements for the past three financial years. If the transaction takes place after some time has passed since the company’s last account’s date, the sellers will also represent and warrant that there have been no significant events, activities, or arrangements since the last account’s date that are outside the ordinary course of the company’s business.
The sellers also represent and warrant that, all tax returns of the company have been timely filed and that all payments of taxes have been made in a timely manner, and that the company is not subject to any tax penalties imposed for tax purposes or any known impending tax audits.
Assets, agreements and employments
The sellers represent and warrant that the company owns all property necessary for the operation of the company’s business and that all agreements essential to the operation of the company’s business are in force in accordance with their terms. A separate seller’s representation and warranty will also be given in the transaction agreement regarding any intellectual property rights that the company may own, as the intellectual property rights owned by the company often form an important part of the company’s business and it is therefore important to represent and warrant that the company owns all the intellectual property rights necessary for its operations. Certain representations and warrants are also made in relation to the company’s employees, for example that the company has complied with its legal obligations as an employer and that the company is not aware of any employment disputes.
Law and disputes
In connection with a transaction, the sellers will usually also represent and warrant that the company has complied with all applicable laws, regulations, permits and other terms and conditions applicable to the company’s business. In addition, the sellers generally represent and warrant that the company has not, during the past years, been involved in or subject to any litigation, arbitration, administrative proceeding, or dispute that could give rise to a judgement, order, or other liability. Further, sellers may represent and warrant that they are not aware of any threat of such proceedings and that no claims or other demands have been presented against the company.
Buyer’s representations and warranties
It is common that the share purchase agreement or business purchase agreement also includes some representations and warranties given by the buyer. These representations and warranties generally relate to the existence of the buyer and its capacity and competence to conclude the transaction agreement in accordance with the terms of the agreement. It is also usual for the buyer to represent and warrant that the information that the seller has provided and information that the buyer has received, together with due diligence, has not revealed to the buyer any facts that would make the buyer aware that the seller would be in breach of any of the representations and warrants given to the buyer in the transaction agreement or any other terms of the agreement that could cause the buyer to suffer loss.
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