In the world of mergers and acquisitions (M&A), representations and warranties are the backbone of a successful transaction. They are designed to protect both the buyer and the seller by allocating risks and ensuring that the deal value is maximized. In this blog post, we will explore the importance of representations and warranties in M&A agreements and provide some strategies for negotiating favorable terms, in addition to discussing the implications of inaccurate representations and the potential remedies available to parties.
- Importance of Representations and Warranties in M&A Agreements
Representations are statements made by one party to another about past or existing facts or circumstances relating to the transaction. Warranties, on the other hand, are assurances that certain conditions or facts will remain true. Both representations and warranties are crucial in M&A transactions, as they serve to allocate risks between the parties and provide a basis for potential remedies in the event of a breach.
For buyers, representations and warranties serve to obtain and confirm information about the target company and its assets, liabilities, and ongoing operations. This information is critical in assessing the value of the target company and determining the appropriate purchase price. Furthermore, representations and warranties provide a level of assurance to the buyer that the seller is not aware of any material adverse facts or liabilities that could negatively impact the target company’s value.
For sellers, representations, and warranties function as a tool to limit their exposure to potential liabilities and indemnification claims post-closing. By providing accurate and thorough representations and warranties, sellers can minimize the likelihood of future claims and disputes arising from the transaction.
- Strategies for Negotiating Favorable Terms
An experienced M&A attorney can help clients negotiate favorable terms in the representations and warranties by:
a) Conducting thorough due diligence: By investigating the target company’s assets, liabilities, and operations, buyers can identify potential risks and negotiate appropriate representations and warranties to address these concerns. Thorough due diligence will assist a buyer in understanding the true value of a business and the condition of its existing operations. Buyers can also utilize representations and warranties to ensure that the target company’s financial statements are appropriately reconciled and prepared in accordance with generally accepted accounting principles (commonly referred to as “GAAP”). Appropriate disclosures on the part of a seller can help facilitate a clean exit from the business.
b) Tailoring representations and warranties to the specific transaction: Each M&A deal is unique, and the representations and warranties should be tailored to address the specific risks and concerns of the parties involved. This analysis can involve limiting joint representations and warranties where multiple parties are involved. Representations and warranties can also vary depending on the industry-specific requirements of the target company. For instance, the acquisition of a government contractor oftentimes necessitates a unique set of representations and warranties, due diligence requests, and risk mitigation strategies.
c) Utilizing materiality and knowledge qualifiers: Materiality qualifiers limit the scope of a representation or warranty by excluding immaterial matters from its scope. Knowledge qualifiers can limit the scope of a representation or warranty to the actual knowledge of the relevant party Each can help to reduce the risk of a breach and potential indemnification claims.
d) Negotiating appropriate survival periods: The survival period is the period during which a party may bring a claim for a breach of a representation or warranty. A shorter survival period can benefit the seller by limiting the time during which they may face indemnification claims.
- Implications of Inaccurate Representations and Potential Remedies
Inaccurate representations and warranties can have significant consequences for both buyers and sellers. If a buyer discovers that a representation or warranty was inaccurate, they may have various remedies available, including:
a) Indemnification: The buyer may seek indemnification from the seller for losses incurred because of the breach.
b) Termination of the agreement: If the breach is material and the buyer has not yet closed the transaction, they may have the right to terminate the agreement.
c) Rescission: In certain circumstances, the buyer may seek to rescind the transaction, essentially unwinding the deal and returning the parties to their pre-transaction positions.
- The Role of Disclosure Schedules in M&A Transactions
Disclosure schedules play a vital role in M&A transactions by providing a comprehensive list of exceptions to the representations and warranties made by the seller. By clearly outlining these exceptions, disclosure schedules can help minimize the risk of future disputes and indemnification claims.
An M&A attorney can assist clients in preparing accurate and thorough disclosure schedules by:
a) Reviewing due diligence materials: The attorney can identify potential issues and exceptions that need to be included in the disclosure schedules. For instance, a careful review of the target company’s existing agreements can ensure that the parties do not run afoul of anti-assignment, notice, or termination provisions, and that the company can continue its customary operations following the transaction.
b) Ensuring consistency with the agreement: The disclosure schedules should be consistent with the representations and warranties contained in the M&A agreement to avoid potential disputes. The parties should also seek to limit the scope of representations and warranties, where appropriate, to avoid the unduly burdensome task of scheduling information that is immaterial to the transaction.
c) Organizing and categorizing disclosures: Proper organization and categorization of the disclosure schedules can make it easier for the buyer to review and understand the information provided.
- The Use of Representations and Warranties Insurance
Representations and warranties insurance is an increasingly popular tool used in M&A transactions to further allocate risks between the buyer and the seller. This insurance provides coverage for losses resulting from breaches of representations and warranties made by the seller in the M&A agreement.
By utilizing representations and warranties insurance, parties can:
a) Bridge gaps in negotiations: The insurance can provide a solution for disagreements over the scope of representations and warranties or indemnification provisions.
b) Expedite the closing process: With the insurance in place, parties may feel more comfortable moving forward with the transaction, potentially accelerating the closing timeline.
c) Enhance deal value: By reducing the risk of potential indemnification claims, representations and warranties insurance can increase the overall value of the transaction.
An M&A attorney can help clients understand the benefits and limitations of representations and warranties insurance and assist in negotiating favorable terms with the insurance provider.
The role of representations and warranties in M&A transactions is critical in minimizing risks and maximizing deal value. By engaging an experienced M&A attorney, parties can effectively navigate the complexities of these provisions, negotiate favorable terms, and ensure a successful transaction outcome.
If you have questions on M&A prospects or otherwise need assistance with a potential acquisition, please contact Nathaniel Scott at 703.284.7271 or nscott@beankinney.com.
This article is for informational purposes only and does not contain or convey legal advice. Consult a lawyer. Any views or opinions expressed herein are those of the authors and are not necessarily the views of the firm or any client of the firm.