The representations and warranties section of the Purchase Agreement, together with the indemnity section discussed below, is typically the most negotiated section of the agreement. Representations and warranties are statements of fact and promises about something. The Seller and its owners will be making several representations and warranties about the Target and its assets. If the Transaction is stock deal, there will also be representations and warranties about the Target’s equity. While the Buyer may have conducted its own due diligence, it will still expect the Target and Seller to confirm several facts and circumstances through the representations and warranties, and then stand behind them through their indemnification obligations. Representations and warranties are made as of the date of the Purchase Agreement and, if the closing will take place on a later date, they will be re-made as of the closing date through a “bring down” certificate. In the course of negotiations with the Purchaser, the Seller will seek to qualify or limit the scope of the representations and warranties to limit its risk and exposure. This is accomplished by adding time, materiality and knowledge qualifiers, and by qualifying the representations and warranties to information disclosed on the disclosure schedules.
The Disclosure Schedules are prepared by the Seller and will contain various facts, exceptions or clarifying information relating to the representations and warranties. From the both parties’ perspective, full disclosure is critical, as the Purchaser will be taking the Purchased Assets or equities subject to all disclosed issues and matters. From the Purchaser’s perspective full disclosure is important so that there are no surprises after the closing. The Purchaser wants to know that it will be getting the benefit of its bargain, and if there are issues, then it will require the Seller to provide specific indemnities to cover any potential losses. If there were material, unexpected issues, between signing the Purchase Agreement and closing then the Purchaser might terminate the deal or require a reduction to the purchase price.
The Disclosure Schedules may require a good deal of time and attention to prepare, so it is important that the Seller begins preparing them as early as possible. Often, the Seller’s chief financial officer handles their preparation in conjunction with Seller’s attorneys. If the closing of the transaction will not occur simultaneously with the signing of the Purchase Agreement, then the Disclosure Schedules will need to be updated at the closing. This time commitment is an important consideration that is not always appreciated by Sellers. If the Seller is spending the majority of time attending to the transaction, then the business might suffer, which, in turn could have a negative impact on the purchase price or earn-outs.
While the ultimate scope of will depend on the size and nature of the transaction, the Target and Seller will generally make the following representations and warranties:
- Legal and Authorized Transactions: That the Purchase Agreement constitutes the legal, valid and binding obligation of the Target and each Seller party, enforceable against them in accordance with its terms.
- No Conflict; Third Party Consents: That the Target’s and each Seller party’s execution and delivery, and performance of the Purchase Agreement, do not and will not (i) violate or constitute a default under any other contract; (ii) violate any provisions of any law, rule, regulation, order, judgment or decree applicable to either or any of their assets; or (iii) require notice to or the consent, approval or waiver of any governmental authority or of any other person or entity.
- Authority: That the Target and each Seller party has (i) full legal right, capacity, power and authority to execute the Purchase Agreement and to consummate the transactions contemplated it, and (ii) all authorizations, consents and approvals required by any other applicable contract, law, regulation or other restriction.
- Title: If the transaction is an asset transaction, that the Target owns, possesses and will transfer and deliver to Purchaser, good, valid and marketable title to the Purchased Assets, free and clear of all liens, encumbrances and rights of third parties.
- Compliance with Laws: That there are no violations or alleged violations by Target or any Seller party of any law, regulation, order or other legal requirement relating to the Target, its equity, assets or the transaction.
- Licenses and Permits: That the Target has all required licenses and permits.
- Litigation: That there are no claims, lawsuits, investigations, or judgments relating to the Target, its equity, assets or the transaction.
- Organization: That the Target and each Seller party that is not a natural person, is organized, existing, and in good standing under the laws of its jurisdiction of organization and in each jurisdiction that requires qualification to do business, and that the Target has delivered to Buyer true and complete copies of its organizational documents, and is not in default under any of them.
- Corporate Power: That the Target and each Seller party that is not a natural person has the requisite corporate power and authority to conduct its business, to own or lease and to operate and use its assets and properties, and to perform all its obligations under its contracts. Ownership of Target Company; No Subsidiaries: That each Seller party ownsall of the issued and outstanding equity interests of Target free and clear of all liens, encumbrances and rights of third parties; that there are no subsidiaries of Target; that all of the issued and outstanding equity securities of Target were issued in compliance with all applicable federal and state securities laws and corporate formalities.
- Equity Securities: If the transaction is a stock transaction, that no third party owns has interest in any equity securities of Seller parties or any right to have any equity securities of Target issued; that there are no voting agreements or agreements to issue or transfer any equity securities to any third party; that at the closing, Purchaser will receive good title to all issued and outstanding equity securities of the Target, free and clear of all liens, encumbrances and rights of third parties.
- Financial Statements: That the financial statements delivered to Purchaser (i) are, true and complete, (ii) have been prepared from and in accordance with the books and financial records of the Target, (iii) have been prepared in accordance with generally accepted/sound accounting principles, (iv) present fairly and accurately the financial condition and results of operations of the Target, (v) the books and financial records that were used as source documentation for the preparation of the financial statements are true and correct and reflect only actual transactions and have been maintained in accordance with sound business practices.
- No Undisclosed Liabilities: That there is no debt or other liabilities with respect to the operation or conduct of the Target, its business or the ownership of the purchased assets or equity securities, other than (i) those disclosed in or reserved against in the aforementioned financial statements, (ii) those incurred in the ordinary course of business since a particular date and similar in nature to those disclosed in or reserved against in the financial statements, or (iii) if Purchaser is assuming certain liabilities, those included in those assumed liabilities.
- Absence of Certain Changes: That the Target has conducted its business only in the ordinary course of business and there has not been any material adverse change to the Target or its business or assets.
- Title; Sufficiency of Purchased Assets: That each Seller party owns, and at the closing will transfer and deliver to Purchaser, good, valid and marketable title to, all of the purchased assets, in each case free and clear of all liens, encumbrances and rights of third parties; that the purchased assets constitute all of the material assets, properties and rights necessary for the operation and conduct of the Target’s business; that the tangible personal property is in good operating condition and repair (with the exception of normal wear and tear), is free from defects, and is suitable for its present uses, and all items of tangible personal property are located at Target’s premises.
- Contracts: that, except as set forth in the applicable disclosure schedule, the Target is not bound by any contract, lease or other agreement; that the contracts set forth on the applicable disclosure schedule are each (i) a legal, valid and binding obligation of Target and the other parties thereto, (ii) in full force and effect in accordance with its terms and (iii) may be assigned to Purchaser and will continue in full force and effect after closing; that there are no breaches or defaults under any such contract; and that the Seller parties have delivered to Purchaser a true and complete copy of each such contract.
- Tax Matters: That the Target has timely filed all required tax returns; that all such tax returns are true, complete and correct in all material respects; that all taxes have been timely paid in full; and that there are no tax contests, audits or liens.
- Full Disclosure: That the Purchase Agreement does not contain any untrue statement of a material fact and does not omit to state any material fact necessary to make the statements made, in the context in which made, not false or misleading.
- No Brokers: That there is no broker, finder, investment banker or other intermediary entitled to any fee or commission in connection with the transaction.
Depending on the nature of Target’s business, there may be a number of other representations and warranties specific to the business, such as those regarding:
- Customer and Suppliers.
- Product Warranties to Customers.
- Customer Credits.
- Intellectual Property and Confidential Information.
- Employee and Labor Matters.
- Environmental, Health and Safety Matters.
- Real Estate.
- Insurance Matters.
- Affiliate/Related Party Transactions.
- Securities and Investment Representations (if Seller will be receiving equity in Purchaser as part of the purchase price).
The representations and warranties of Purchaser are usually limited to the following:
- Legal and Authorized Transactions
- No Conflict; Third Party Consents
- No Litigation
- Corporate Power
If Purchaser will be issuing equity securities to the Seller, then it may be required to make additional representations and warranties closer to the scope given by the Seller and Target.
For information on negotiating an M&A deal, we recommend this webinar and this webinar.