REPRESENTATIONS & WARRANTIES CLAUSES IN M&A DEALS

REPRESENTATIONS & WARRANTIES CLAUSES IN M&A DEALS

Representations & Warranties (“R&W”) are very common clauses used in M&A deals to give assurance with regards to the situation of the target company. In Spanish-speaking countries, this term is sometimes mistranslated as “representaciones y garantías”, but the appropriate equivalent would be either “declaraciones y garantías” or “manifestaciones y garantías”.

In Spain, the concept of a so-called “Representations and Warranties” clause has been imported from the laws of countries such as the USA or the UK. However, this type of clause is gradually gaining ground in agreements seen in local M&A deals.

REPRESENTATIONS & WARRANTIES: WHAT ARE THEY?

R&W contain assertions as to certain facts, with the intention of persuading the purchaser to enter into a sale and purchase agreement. They introduce a series of circumstances that may affect the contents of the contract or influence the decision of one of the parties as to whether to conclude such a contract or not.

PURPOSE OF R&W CLAUSES

R&W are meant to determine and apportion any potential risks that are intrinsic to M&A transactions.

·         Informative value (representations). R&W clauses introduce relevant information with regards to the contract execution, such as the seller’s ownership of the goods or assets to be sold, the financial status of the target company in the selling-buying process, the various permits or licenses in place, industrial and intellectual property, any existing litigation, tax & social security obligations, and so on.

·         Warranty and allocation of responsibility value (warranties). R&W clauses guarantee that the information provided is accurate.

R&W clauses are not simple declarations of good intentions. The seller will be held liable for their veracity and accuracy. A breach of warranty can have major consequences: although it does not amount to a breach of contract, it does allow the injured party to claim damages.

LIABILITY REGIME: TEMPORAL AND QUANTITATIVE LIMITS

The liability regime of R&W clauses establishes certain duration and quantitative caps:

·         Temporal limits or survival period. A seller’s liability cannot be held indefinitely, and is usually limited to between 12 and 24 months. However, labour responsibilities and tax & administrative liabilities are governed by the applicable legal prescription periods.

·         Quantitative or indemnification limits. The most frequent are:

o   Indemnity cap: the maximum amount for which the seller can be liable. This is usually connected to the transaction price.

o   De minimis: the minimum amount that a certain damage or loss must exceed before a seller can be held liable for compensation.

o   Indemnity basket: the threshold that damages or losses must exceed before a seller is liable for any compensation payments. This can be from euro one, or only if such damages or losses exceed a certain tipping basket amount.

Wilful default and fraud cases are usually excluded from these temporal and quantitative limitations – as well as those issues arising from the capacity to execute the contract, the ownership of the shares, and the actual existence of the target company.

Finally, it is customary to define the claim procedure to follow should any of the contingencies foreseen by a R&W clause come into being.

INDEMNITY CLAUSES

Indemnity or indemnification clauses focus on known, anticipated risks that are excluded from the general liability regime of temporal & quantitative limits, and from the applicable claim procedure. This is because there are specific remedies that apply to those risks.

For example, it is possible to sign an indemnity clause establishing that, in the event of tax liabilities arising from previous improper deductions, the seller will have to pay for the total damage or loss incurred (including the principal amount, plus any penalties or charges).

AN INDISPENSABLE CLAUSE FOR MERGERS AND ACQUISITIONS

For the above reasons, R&W clauses should be an inseparable part of any M&A agreement.

They must be written very carefully to avoid any potential misunderstanding or conflict. Therefore, we recommend that this task be entrusted to a specialised firm such as .