Representations and warranties in M&A contracts

Those who are not familiar with M&A contracts are often surprised that a major part consists of dealing with the so-called ‘Representations and Warranties’. Often, these ‘Representations and Warranties’ are drafted in a specific annex. It’s likely it counts more pages than the contract itself. But why is it this important?

SHARE PURCHASE AGREEMENT

The answer is found in the way many of these M&A transactions are structured. They are a transfer of company shares from one owner to a new one. The primary purpose of such transactions is the shares themselves. The corresponding share purchase agreement (SPA) enhances the sale-purchase of these shares and their transfer of title. Within this strict scope, the liability of the seller to the buyer is limited to the shares themselves. The seller shall bear no – automatic – responsibility regarding the underlying target company, its finances, or profitability.

However, it is obvious that the buyer in such transactions is interested in obtaining control of the target company and its business activities, in exchange for payment of share price. In addition to opportunities, these activities may include certain risks. As the previous owner, the seller is much more aware of these risks than the buyer (even if the latter has performed a due diligence investigation).

CONTRACTUAL PROTECTION

Representations and Warranties in the Share Purchase Agreement (SPA) provide the buyer with contractual protection against these risks, as they will include guarantees regarding (but not limited to):

• the legal and financial status of the target company;
• quality of its assets and debts;
• (payment) obligations regarding employees, social security, and taxes;
• status and value of IP, insurance, commercial contracts, public licenses, and environmental obligations;
• contingencies and potential hazards (such as pending litigation).

The Representations and Warranties substantially enlarge the possible liability of the seller toward the buyer. They go further than the mere “shares”.

Negotiations on these ‘Representations and Warranties’ are therefore often complex and delicate, given the clear conflict of interest between parties: the buyer wants to protect himself as much as possible, whereas the seller wishes to keep his liability rather limited (or even excluded). It is recommended for both buyer and seller to rely on high-end advice, not only legal but also financial and business-wise.

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