Posted & filed under Business Law.

When buying or selling a business, more often than not it is the negotiation and documentation of the representations and warranties that requires the most time and effort on the part of attorneys.  While clients typically take on negotiating the major points of the deal (purchase/sales price, form of the transaction, and timing) the attorneys focus much of their time and energy on the representations and warranties to be made by the parties in connection with the transaction.

What are representations and warranties?  Basically, representations and warranties are statements of fact, which are made by the seller of a business to induce the buyer into purchasing the business and to provide the buyer with certain assurances with respect to the business. Typical representation and warranties made by the seller will include statements that: the seller’s business has been properly formed and has the necessary authority to operate and enter into the transaction; the company has never been the subject of a tax audit; the financial statements for the company are true and correct and were prepared in accordance with generally accepted accounting principles; none of the inventory is obsolete or damaged; all required contributions to employee benefit plans have been made; all documents provided by the seller to the purchaser are true and correct; there are no environmental issues.  The list goes on and on.  The specifics that go into the representations and warranties section of a transactional agreement are heavily negotiated, the buyer wants the seller to represent and warrant as much as possible and the seller wants to represent and warrant as little as possible.

Representations and warranties are crucial for several reasons:

  • They force the disclosure of information about a business that the seller may not have been forthcoming about;
  • They set the conditions for closing the deal; and
  • They set the groundwork for liability and indemnification if actual facts are not as were represented in the purchase or sale document.

Why are the representations and warranties made by the seller so much more detailed and comprehensive then those made by the buyer?  It is typically the buyer who is taking on most of the risk when it comes to purchasing a business.  It is the seller that has the knowledge regarding the business, its past performance and operations, and whether there are any known facts or circumstances that may hinder the ability of the business to continue as a going concern.  Typically, the buyer’s representations and warranties include statements that the buyer is authorized to enter into the transaction and that they are able to finance the transaction.  In reality, the seller of a business is just looking to get paid, not much else.

In the typical purchase and sale transaction, the survival periods for the various representations and warranties made by the seller are heavily negotiated.  Of course, the buyer would like the survival periods to last as long as possible whereas the seller wants to limit the duration of the survival periods.  The longer the survival period, the longer the seller will be responsible for indemnifying the buyer for any breaches of the representations and warranties discovered, as well as for fraud. Certain representations and warranties known as “fundamental” should survive the transaction indefinitely, like the seller’s authority to enter into the transaction and their good title to the assets or the stock being transferred.  Others will have a much shorter survival period, sometimes based on the relevant statute of limitations for a particular area and others are purely a matter of negotiation.

Representations and warranties are an essential component in all purchase and sale transactions and should not be negotiated or drafted in haste just to get the deal closed.  If you are thinking about buying or selling a business, it will serve you well to set aside the time and resources that will be necessary for this aspect of your transaction.