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The Role of Representations and Warranties In Private Acquisition Agreements

In a private acquisition, the seller and buyer will make many factual representations to one another. These statements are called representations and warranties, and they set forth the premises on which the parties rely in agreeing to the deal. Representations and warranties also form a basis for liability if the actual facts do not match what the party receiving the facts expected, allowing the aggrieved party to make a claim. Besides forming a basis for liability, the representations and warranties also establish the conditions for closing the acquisition.

Representations and warranties create the factual base and the framework upon which many of the other provisions rely. They form the basis for a buyer’s right to indemnification for problems or unforeseen risks, and as mentioned are integral to the closing conditions. They are usually the longest part of an acquisition agreement and take a significant amount of time to negotiate. In light of their centrality and importance, it is vital that all parties to a deal understand the purpose of representations and warranties, and how they might be limited.

During the deal making process, the buyer and seller generally negotiate the scope of the representations and warranties, which might include anything from the ownership status of specific assets to the financial attributes of a party including creditworthiness. The seller is generally in a superior position to know the facts upon which a buyer will rely in valuing the deal and ultimately deciding whether to consummate the deal. Therefore, the buyer’s aim is to get comprehensive representations and warranties in order to ensure accurate and complete knowledge of what is being purchased.

On the other side of the table, the seller will prefer to give as few representations and warranties as possible. The seller will strive to limit the scope of the representations and warranties it has to give, in order to add certainty and limit liability. To that end, the seller might limit the representations and warranties in several ways.

The seller may circumscribe its liability by limiting the scope of a representation or warranty to certain materials. To do this the seller might, for example, include only materials found on an attached list, specifically excluding any similar or related materials that do not appear on the list. Such a limitation enables the seller to discover with relative certainty whether all of the included materials conform by the time the deal closes. And for those non-conforming materials, the scope of liability will be apparent.

Second, the seller might also qualify a representation or warranty by what is tightly defining what is material or what might cause a material adverse effect. How the parties define a “material adverse effect” substantially impacts the application of qualifiers to the representations and determining when whether a closing condition has been satisfied. The seller might also impose time constraints that truncate the applicability of a particular representation or warranty, limiting the effect to a specified time and date or a particular period.

The seller might also define “knowledge” narrowly, limiting knowledge to actual knowledge only in order to avoid costly due diligence work and eliminate further uncertainty from the deal. The buyer’s best interest is to define knowledge constructively, indicating what the seller knew or should have known. By doing so, the seller will be deemed to know what it would have known had it conducted a reasonable investigation into the facts being represented.

A final common liability-limiting mechanism that may be used is the seller’s limitation of a representation or warranty by reference to disclosure schedules (“schedules”). These documents supplement the representations and warranties contained in an agreement. Schedules allow the disclosing party to list exceptions to the agreement and to add information that is otherwise too lengthy or cumbersome to insert into the main agreement. When the representations and warranties are limited in this way, it becomes incumbent on the buyer to thoroughly review and cross-check the disclosure schedules in order to identify any gaps that could affect the value or viability of the deal.


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