Wednesday, October 6, 2010

Representations and Warranties

 "Why do we have to have all these Representations and Warranties?" 

That is a common complaint in merger and acquisition transactions (and other transactions for that matter).  For example, a 75-page purchase and sale agreement might have 30 pages of reps and warranties in which the seller certifies various facts about the seller's company. 

The Seller's reps and warranties serve at least three important functions in a purchase and sale agreement:

(1) They serve a disclosure function.  By asking the seller to rep and warrant facts about the seller's company, the buyer learns valuable information about what may be less-than-perfect about the seller's business.  For example, if the purchase and sale agreement asks the seller to rep and warrant that the seller's company has no pending litigation, the seller would (or at least should) disclose that the seller's company has just been sued by one of its largest customers.

(2) They give the buyer an "out" to avoid closing.  The purchase and sale agreement typically provides that the deal will not close unless all of the seller's reps and warranties are true and correct in all material respects as of the signing date and as of the closing date.  Therefore, if the buyer becomes aware of an inaccurate rep or warranty during its pre-closing due diligence period, the buyer may be able to refuse to close the deal or may be able to demand concessions from the seller prior to the closing.  For example, if the buyer learns before the closing that the seller's company has spilled hazardous materials on one of its properties that was not disclosed by the seller in the purchase and sale agreement, the buyer might request a reduction of the purchase price. 

3) They give the buyer the right to sue the seller.  If the purchase and sale agreement provides that the seller's reps and warranties "survive" the closing, then the buyer can typically sue the seller for breach of contract during such survival period if the buyer can prove that one or more of the seller's reps and warranties was inaccurate as of the closing date. 

Of course, no seller likes to make pages and pages of representations and warranties, but those reps and warranties are typically critical to a buyer to assure the buyer is really getting the company that the buyer expects. 

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