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Representations and warranties in M&A contracts: purpose and importance

Hans Van Gompel – October 2021 – Those who are not familiar with M&A contracts are often surprised that a major part of the contract is dealing with the so-called ‘Representations and Warranties’. Often, these ‘Representations and Warranties’ are drafted in a specific enclosure. Its likely they have more pages than the contract itself, the question raising: why?

The answer is connected to the way many of these M&A transactions are structured.

They are to be seen as a transfer of company shares from one (previous) owner to another (new) owner; the primary purpose of such transaction being the shares themselves. The corresponding share purchase agreement (SPA) enhances the sale-purchase of these shares and their transfer of title. Within this strict scope, the liability of the seller to the buyer is limited to the shares themselves, that is: a peace of paper or a mere transcription in a share register. The seller shall bear no – automatic – responsibility regarding the underlying target company, its finances neither profitability.

However, it is obvious that the buyer in such transactions is interested in obtaining control of the target company and its business activities, in exchange for payment of share price. In addition to opportunities, these activities imply (a lot of) risks. As previous owner, the seller knows these risks much better than the buyer (even if the latter has duly performed a due diligence investigation).

‘Representations and Warranties’ in the SPA provide the buyer with a contractual protection against such (unknown, difficultly measurable) ‘company’-risks, as they will include guarantees regarding a.o.:

  • legal and financial status of the target company;
  • quality of its assets and debts;
  • (payment) obligations regarding employees, social security and taxes;
  • status and value of IP, insurances, commercial contracts, public licenses, environmental obligations;
  • contingencies and potential hazards (such as pending litigation).

The ‘Representations and Warranties” substantially enlarge the possible liability of the seller towards the buyer. They go further than the mere “shares”.

Negotiations on these ‘Representations and Warranties’ are therefore often complex and delicate, given the clear conflict of interest between parties: the buyer wants to protect himself as much as possible, where the seller wishes to keep his liability rather limited (or even excluded).

It is recommended for both buyer and seller to count with high end advice, not only legal, but also financial and business wise.

Do you have a pending or proximate M&A transaction?

Do not hesitate to contact VGA at +32 (0)11/281.280 or info@vangompeladvocaten.be.

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