A General Overview
Representations and warranties are arguably the most important section of any purchase agreement. In simple terms, they are statements of fact, assurances, and promises made by the parties regarding various business and legal matters in connection with the transaction. These provisions are often heavily negotiated, as they play a significant role in determining the allocation of risk and liability between the parties. Although representations and warranties appear in both share and asset purchase agreements, this discussion will focus on share purchase transactions for clarity and simplicity.
The seller’s representations and warranties are intended to give the purchaser confidence in the transaction, support their due diligence process, and hold the seller accountable for the accuracy of the information provided. For sellers, these representations often include, without limitation, assurances about the condition of the business (including financial statements), litigation matters, environmental compliance, an employee census, and guarantees about the seller and the target’s corporate existence, share capital, and authority to enter into the purchase agreement. The latter three are often referred to as “fundamental representations.”
Purchasers also provide representations and warranties, though typically in a more limited form. These usually cover only fundamental representations. Their purpose is to give the seller confidence that the buyer has the authority, financial capacity, and legal compliance necessary to complete the transaction. In essence, they provide a legal basis for the seller to seek remedy if the buyer fails to meet its obligations under the agreement.
Key Seller Representations and Warranties
Below is an outline of key representations and warranties that typically require extra attention by the sellers and their counsel:
- Taxes: Tax-related representations and warranties reassure purchasers that the company’s tax affairs are accurate, compliant, and up to date. Sellers confirm that the company has filed all required tax returns and reports and has paid, withheld, and remitted all taxes, interest, and penalties on time. Filed returns are stated to be complete and accurate in all material respects, with no ongoing or threatened audits, assessments, or legal proceedings. Sellers further confirm that the company is not subject to tax in jurisdictions where it does not file returns and is compliant with sales tax requirements, including GST/HST and provincial taxes. Finally, financial statements are represented to include sufficient provisions for all accrued and unpaid taxes up to the closing date. It is prudent for sellers to have their accountant review the tax representations to ensure accuracy.
- Environmental Compliance: Sellers typically represent that the company’s operations and the condition and use of any leased real property comply with all applicable environmental laws.
- Insurance: Sellers confirm that all of the company’s insurance policies are active, valid, and in good standing. The company has paid all premiums, complied with policy terms, submitted claims in a timely manner, and had no claims denied. This warranty assures the purchaser that insurance coverage is current, compliant, and reliable.
- No Material Adverse Changes: Sellers confirm that, since the date of the company’s most recent annual financial statements, there have been no significant changes to its financial condition, operations, or prospects beyond ordinary course business activities. In other words, nothing has occurred that would have a material adverse effect on the company’s overall business or value, providing purchasers with confidence in the stability of the business leading up to the sale.
Carve-Outs from Representations and Warranties – Knowledge Qualifiers and Disclosure Schedules
Some representations include language like “to the knowledge of the Seller”, this phrase is known as a knowledge qualifier. It limits the scope of the statement, meaning the seller is only representing facts they actually know (or, in some cases, should reasonably know), rather than guaranteeing something absolutely. Knowledge qualifiers shift some risk from the seller to the purchaser, who assumes the risk of unknown issues outside the seller’s knowledge. The effect depends on how “knowledge” is defined in the agreement, which can range from actual personal knowledge to knowledge after reasonable inquiry.
Disclosure schedules complement knowledge qualifiers by allowing sellers to provide exceptions, clarifications, or additional details without undermining their general assurances. For example, if a representation says, “The Company is not involved in any litigation,” the disclosure schedule can list any known or pending claims. This protects the seller from breaching the agreement while giving the buyer transparency. Disclosure schedules are commonly used for intellectual property, contracts, tax matters, leases, employee plans, and regulatory compliance. Sellers must review disclosure schedules carefully to avoid post-closing liability for misstatements or omissions, while buyers rely on them to understand what risks they are assuming.
Indemnification Obligations
Representations and warranties are typically paired with indemnities, which provide recourse for buyers and sellers in the event of a breach. In simple terms, indemnification allows a party to seek compensation if a promise in the agreement turns out to be false and the purchaser suffers a loss because of it. This connection ensures that the representations and warranties are not just statements of fact, but enforceable assurances with financial remedies if they are inaccurate.
Fundamental Representations
It is important to note that “fundamental representations” are often treated differently from standard representations and warranties in terms of survival and indemnification obligations. Regular representations usually only survive for a short period after closing, often one to two years. In contrast, fundamental representations may survive much longer, sometimes indefinitely, because they cover critical deal issues. While indemnification obligations for regular representations are typically capped, obligations for fundamental representations may be uncapped or capped at the total purchase price, reflecting their importance to the transaction.
Conclusion
Representations, warranties, and disclosure schedules aren’t just legal jargon—they’re the backbone of M&A deals. They protect buyers, limit sellers’ post-closing liability, and link directly to indemnification if promises fall short. Getting them right ensures transparency, reduces risk, and helps the deal close smoothly. For strategic guidance on reviewing representations and warranties, kindly contact our firm and stay tuned for additional posts in this M&A series.
