The Purchase Agreement Essentials: Representations and Warranties

Protecting Yourself with Representations and Warranties

The representations and warranties section is one of the most negotiated sections of a purchase agreement between a buyer and seller. It covers statements of fact and promises about what is sold.

While the buyer may conduct their own due diligence, they will still expect the seller to confirm several facts in this section. The seller will also need to stand by those facts throughout the selling process.

Development

In the course of negotiations, the seller will seek to delineate the scope of the representations and warranties section to limit their risk and exposure. This is accomplished by adding time, materiality, and knowledge qualifiers.

Representations and warranties go into effect on the date the purchase agreement is signed. If the closing takes place on a later date, the representations and warranties will be re-made. This happens on the closing date through a ‘bring down certificate,’ also known as the ‘bring down condition.’

Disclosure Schedules

The representations and warranties are also included in what is known as the disclosure schedules, which are prepared by the seller. These schedules contain various facts, exceptions, and clarifying information about the representations and warranties.

Full disclosure here is critical. There should be no surprises after closing. If there are issues, the seller must provide specific indemnities to cover any potential losses to the buyer.

If any material, unexpected issues arise between signing the purchase agreement and closing the deal, the buyer could request a reduction in the purchase price or even terminate the deal entirely.

Time is of the Essence

The disclosure schedules require a good deal of time and attention to prepare. Often, the seller’s chief financial officer (CFO) and attorneys prepare these schedules.

This time commitment is an important consideration that is not always anticipated by sellers, so it is important to begin preparing them as early as possible and set aside sufficient time and attention to do so. This is particularly important if the subject of the transaction, like an active business, requires the seller’s day-to-day attention.

Elements of Representations and Warranties

The ultimate scope of the representations and warranties will depend on the size and nature of the transaction. However, regardless of transaction size, the seller’s representations and warranties will generally fall into the categories of finances, ownership, law, and miscellaneous and address several fundamental concepts within each.

Finances

Financial Records

• All financial records have been maintained in accordance with sound business practices, are true and accurate, and reflect only actual transactions.

Financial Statements

• The financial statements provided have been prepared from the financial records mentioned above.
• These statements have been prepared in accordance with sound accounting principles, accurately represent the financial condition and operations of the business, and are complete.

Undisclosed Liabilities

• There is no debt or other liabilities tied to the business other than those disclosed in the aforementioned financial documentation, incurred in the ordinary course of business, or similar in nature to those disclosed.

Tax Matters

• All tax returns are complete and accurate.
• Any tax liability has been satisfied in a timely fashion.
• There are no active tax contests, audits, or liens.

Ownership

Authority

• The business and seller have the full legal right, capacity, power, and authority to execute the purchase agreement, and consummate the transactions contemplated.
• The business and seller have all authorizations, consents, and approvals required by law, regulation, or other restrictions.

Corporate Power

• The business and seller have the requisite corporate power and authority to conduct their business and perform all obligations under contract.

Ownership of Target Company; No Subsidiaries

• The seller owns issued equity interest in the business and these interests are free and clear of all liens, encumbrances and rights of third parties.
• There are no subsidiaries of the business.
• All issued equity securities of the business were issued in compliance with applicable federal and state laws.

Title and Sufficiency of Purchased Assets

• At closing, the seller will transfer and deliver to the buyer all purchased assets, which will be free and clear of liens, encumbrances, and rights of third parties.
• The purchased assets constitute all material assets, properties, and rights necessary.
• Any tangible property is located on the business’s premises and is in good operating condition and repair, with the exception of normal wear and tear.

Laws

Legal and Authorized Transactions

• The purchase agreement constitutes the legal, valid, and binding obligations of the business and seller.
• These obligations are enforceable in accordance with the terms of the agreement.

Compliance with Laws

• The business has not violated any law relating to its equity, assets, or the transaction.

Licenses and Permits

• The business has all the required licenses and permits.

Litigation

• There are no claims, lawsuits, investigations, or judgments relating to the business, its equity, assets, or the transaction.

Organization

• The business and seller are in good standing under the laws of its jurisdiction of organization.
• The business has been delivered to the buyer with the organizational documents and is not in default under any of them.

Full Disclosure

• The purchase agreement does not contain any untrue statement of a material fact and does not omit any material fact that would make its statements false or misleading.

Contracts

• Except as set forth in the applicable disclosure schedule, the business is not bound by any contract, lease, or other agreement.
• The contracts set forth in the applicable disclosure schedule are each a legal, valid, and binding obligation of the business and the other parties and are in full force and effect in accordance with its terms.
• These contracts may be assigned to the buyer and will continue in full force and effect after closing.
• There are no breaches or defaults under any such contract.
• The sellers have delivered a complete copy of each contract.

Miscellaneous

Absence of Certain Changes

• The company has conducted its business.
• There have not been any material adverse changes to the company, its business, or its assets.

No Conflict; Third Party Consents

• The business and the seller’s execution, delivery, and performance of the purchase agreement do not:
  • violate or constitute a default under any other contract.
  • violate any provisions of any law, rule, regulation, order, judgment, or decree applicable to the assets.
  • require notice to or the consent, approval, or waiver of any governmental authority or any other person or entity.

No Brokers

• There is no broker, finder, investment banker, or other intermediary entitled to any fee or commission in connection with the transaction.

Less Common Representations and Warranties

Depending on the nature of the company’s business, there may be many other representations and warranties, including but not limited to those that fall into the following categories:

• Customer and Suppliers
• Product Warranties to Customers
• Customer Credits
• Intellectual Property and Confidential Information
• Employee and Labor Matters
• Environmental, Health and Safety Matters
• Inventory
• Real Estate
• Insurance Matters
• Affiliate and Related Party Transactions
• Securities and Investment Representations

Buyer Representations and Warranties

The expectations placed on the seller regarding representations and warranties are many and can be quite complex and detailed, as we’ve shown. Though the burden will generally be more significant on the seller, and for good reason, it is important to understand that the buyer will also be required to attest to representations and warranties as well. Generally, the buyer’s representations and warranties will be limited to the following: Legal and Authorized Transactions, No Conflict, Third-Party Consents, Authority, No Litigation, Organization, and Corporate Power. Again, though, the specifics will depend on the transaction’s nature and size.

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Buying & Selling IP
2. Valuation / What’s it Worth? Valuing a Business for Sale
3. M&A Bootcamp Series 

This is an updated version of an article originally published on April 3, 2015 and updated February 10, 2020. This article was most recently updated by the Financial Poise Editors.]

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