Representations And Warranties In Share Purchase Agreements: What Buyers And Sellers Must Know
According to various practice guides, Share Purchase Agreements (SPAs) are the most critical documents in the mergers and acquisitions (M&A) domain. Like any legal document, SPAs dictate the terms of an agreement. The representation and warranty sections are typically at the heart of any SPA. They determine how much risk is allocated to either party, provide assurance around transparency and identify remedies if something went wrong after the closing. This blog post aims to break down these terms for both buyers and sellers and articulate why they are a necessary component of any share transaction.
1. Understanding Representations and Warranties
Representations and warranties come up frequently in each of the contexts above, however there are differences in the meanings of the terms “representations” and “warranties”, at least in legal terms. The differences can be summarized below:
Representations are statements of something related to the past or present made for the purpose of inducing another party to enter into an agreement. If that representation is found to be untrue, the other party will have a remedy available to it known as misrepresentation.
Warranties are different from representations. Warranties are a contractual promise that a representation is true. If there is a breach of warranty, the aggrieved party can sue for damages but is not allowed to rescind that contract.
In SPAs, for practical purposes, these terms are grouped together and treated similarly, effectively providing a buyer with a sword and shield: the “sword” provides a remedy for damages or losses suffered by the buyer as a result of the representations and warranties and the Shield obligates the seller to convey complete or sufficient information.
2. Why Representations and Warranties Matter
- Risk Allocation- The representation and warranty provisions take certain risks away from the buyer and put them on the seller; specifically, in instances where there may be unknown or undisclosed liabilities which could materialize after the closing.
- Due Diligence Support- The Reps and warranties further the due diligence process by requiring the seller to affirm very important facts about the company such as the company’s financial information, operations, compliance status, etc.
- Basis for Indemnification- Any breach creates the basis for indemnification claims which serve as a contractual safety net for the buyer.
- Building Trust- They lessen asymmetry in information, promote transparency, and improve the buyer’s confidence in the deal.
3. KEY SELLER REPRESENTATIONS AND WARRANTIES
Some of the most negotiated and important representations from seller-side perspective include:
- Title and Ownership: Representation that the seller has good and unencumbered title to the shares.
- Corporate Status: Representation that the target company is duly constituted and active.
- Financial Statements: Representation regarding financial statements being correct and complete.
- No Liabilities: Representation regarding no undisclosed debts, liabilities, or contingent liabilities.
- Compliance with Law: Representation regarding compliance with applicable laws and government norms.
- Material Contracts: Representation about material contracts and significant contractual obligations.
- Tax Matters: Representation that tax filings are accurate and up-to-date.
- IP Ownership: Representation about ownership or valid license to intellectual property.
- Employment and Labor Law Compliance: Representation relating to employee compensation, employee contracts, and potential disputes.
- Litigation: A representation regarding any current or threatened litigation.
4. Buyer Representations and Warranties
While it is typical for sellers to assume the bulk of the disclosure obligation in the negotiations of SPAs, buyers are also important in the representations and warranties space for the purpose of deal certainty and for the protection of the seller. The most common (but not exhaustive) buyer representations are:
- Legal Capacity – Buyer is duly formed and is authorized to enter into the Agreement.
- Financial Capacity – Buyer has sufficient assets to complete the purchase.
- No Conflict – the transaction does not breach any laws, contracts, or court orders.
- Regulatory Approvals – all necessary consents and licenses are or will be satisfied.
- Investment Purpose – buyer confirms that in regulated sectors it is acquiring the target for the purposes of investment, not resale.
- Compliance – buyer confirms compliance with applicable anti-corruption, sanctions and anti-money laundering laws.
- No Litigation/Insolvency – buyer is not the subject of any litigations or insolvencies that would affect the transaction.
- Non-Reliance (optional) – buyer agrees it is not relying on any unwritten promise.
The importance of buyer representations is to establish trust, assist in risk allocation and to lend enforceability to the text – it is important even if the representations from buyers is less fulsome than it is from sellers.
5. Impotence of Disclosure Schedules
Disclosure schedules are appendixes to the Share Purchase Agreement that list exceptions or qualifications to the representations and warranties in the Agreement. Disclosure schedules have three primary functions:
- to limit Seller’s liability to the Buyer, as the Seller can disclose items that it knows of, and thereby are not liable for post-closing claims for breaches of warranty
- to uphold transparency by forcing Sellers to disclose material factual matters regarding the company, thereby allowing the Buyer to make an informed decision
- to limit the potential for miscommunication or legal disputes later after closing, as the Buyer will clearly know what it is buying, and what was disclosed in the Disclosure Schedules.
In essence, disclosure schedules act as a suit of armor for Sellers, and a due diligence tool for Buyers.
6. Drafting and Negotiation: Important Points to Note
- Knowledge qualifiers- Qualifiers like “to the best of the seller’s knowledge” qualify the seller’s liability to what they did, or should have reasonably known.
- Materiality- Including materiality standards may limit the buyer’s remedies for the scope of liability. For example, in an SPA the seller is only obligated to disclose issues with a “material adverse effect.”
- Sandbagging clauses- These define whether the buyer can bring claims for breaches known prior to closing. Pro-sandbagging clauses allows claims.
Anti-sandbagging clauses prohibits claims.
- Time limits and financial limits- SPAs commonly include time limits (survival periods) for the reps (typically 12–24 months post-closing), financial caps on seller liability, and baskets – which define a minimum amount of loss before a claim can be made.
7. Comparative Perspective: India, US, and UK
India
Indian law as contained in the Indian Contract Act, 1872 does not formally make a distinction between representations and warranties, even though it recognizes that they are different in practice. SPAs increasingly incorporate international elements like disclosure schedules, indemnity clauses, and materiality qualifiers. The law regarding sandbagging is faintly established in Indian law, but can be enforceable if contracted.
United States
US SPAs draw a distinction between representations (tort remedies) and warranties (contract remedies). The disclosure schedules are quite lengthy. Courts either permit sandbagging or not, and if explicitly waived, then sandbagging is prohibited. R&W Insurance is plainly visible in the market running a class in the transaction to manage post-closing risks and indemnity clauses are cautiously written and contain baskets, caps, and survival provisions.
United Kingdom
UK law distinguishes between representations and warranties. Misrepresentation can be rescinded or damages can arise because of the misrepresentation. Breaching a warranty, only contractual damages will arise from a breach. Sellers use disclosure letters (not schedules) as a primary risk limiting tool. Courts strictly do not Favor the doctrine of sandbagging unless permitted. It was emphasized that buyers rely upon the representations with full and fair disclosure.
8. Best Practices for Stakeholders
For Sellers:
- Conduct Internal Due Diligence: Verify all the information before representations are made.
- Qualifiers: Use knowledge and materiality limits for a further way to reduce liability.
- Disclosure: Disclose clearly and fully using detailed disclosure schedules, before closing to avoid future claims.
- Negotiate your limits: Clearly define any survival period, cap, and basket.
- Avoid Blanket Warranties: Reps must be tailored to the facts.
- Reps and warranties insurance: Use RWI to provide yourself a clean exit.
For Buyers:
- Don’t cut corners on due diligence: Don’t just rely on the reps – independently verify everything.
- Insist on Important Warranties: Representations must be unqualified for title, tax, and compliance.
- Read the Disclosures Carefully: Review all carve-outs and exceptions carefully.
- Obtain Indemnity Protection: Provisions regarding survival period, caps, baskets, and escrow.
- Consider Sandbagging Clauses: Retain your rights to claim even if you knew beforehand of the breach.
- Reps and warranties insurance: Provides protection without complicated transaction negotiations.
9. Case Law
Peek v. Gurney (1873) LR 6 HL 377 (UK)
This case represents an early decision that established the idea that the failure to disclose material facts could amount to fraudulent misrepresentation. The court held that vendors cannot leave out material facts when making representations, particularly in share prospectuses. The case illustrates the principle of full disclosure, which is an important principle in SPAs that can protect from fraud liability.
Shobika Impex Pvt. Ltd. v. Peerless General Finance (2021) SCC OnLine Mad 2116 (India)
This case from India illustrates how courts enforce representations and warranties in SPAs. The vendor was liable for misrepresenting the financial situation of the target company. The judgment provides confirmation that misrepresentations can make the contract voidable and give rise to damages under Indian law.
Omkara Assets Reconstruction Pvt. Ltd. v. Anand Rathi Global Finance Ltd. (2023 SCC OnLine Del 1252) (India)
In this recent case, the Delhi High Court held that failing to disclose material financial defaults by the vendor amounted to a breach of warranty. The case demonstrates Indian courts’ willingness to protect purchasers from undisclosed financial risks and highlights the importance of full disclosure in SPAs.
10. Conclusion
Representations and warranties raise questions related to risk allocation where Share Purchase Agreements are concerned, and help to encourage full transparency between both buyer and sellers. They provide a method of legal recourse in terms of false statements made or breaches that may arise. For sellers they go far to risk or liability management if they are clear and appropriately qualified, and for the buyer they are necessary to provide assurance for their investment. The complexity of a deal may be increasing with the likelihood of a global cross border transaction, as well as representations and warranties insurance being around more frequently, they require understanding of the provisions to be considered and for the ability to negotiate so that the seller and buyer can move forward with their confidence that the deal can move ahead. Ultimately, representations and warranties support a growing level of trust and certainty within share purchase deals.
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