One of the key sections of any purchase agreement is the Reps and Warranties section. The term “Reps and Warranties” refers to all the assertions that the buyer and/or seller make in a purchase and sale agreement. Both sides take a leap of faith in the Reps and Warranties section, assuming that any claims or assertions made by the counter party are accurate and true. Think of the Reps and Warranties section as a safety net for both sides. It ensures all that is being sold is being bought and all that is being bought is being sold.
Representations made by the seller typically include information the buyer is using to value the business. A statement to the buyer that all the information is true and correct is not enough. The seller also provides a host of supporting documentation. This includes financial statements, customer contracts, supplier contracts and more. This data is typically included in separate schedules and can be used for reference post-close if needed.
The Reps and Warranties section is the guide that buyers use for the due diligence process. They give the seller the chance to disclose all potential warts on the deal that could possibly derail the transaction. As an example, the seller must use the Reps and Warranties to disclose any potentially detrimental information—like the knowledge that a large customer is planning not to renew their contract with the business. Failure to disclose any information that is material to the valuation and ongoing success of the business is not permitted.
Representations made by the buyer, in many cases, refer to the consideration used to complete the transaction. Is the transaction a stock deal, a cash deal, or a combination? The buyer must represent clearly that the offering stock is legal. In a stock only deal, the buyer must also provide a shareholder agreement so that the seller can review the document. This is so that they can be sure the stock is not restricted and proper governance controls are in place.
Reps and Warranties Insurance
In some cases, the parties agree to take matters a step further with the implementation of Reps and Warranties insurance. Reps and Warranties insurance covers the indemnification for certain breaches of the representations and warranties in the transaction agreements. Reps & Warranties insurance can be purchased by the seller or the buyer and there are “Sell Side” policies and “Buy Side” policies. Reps and Warranties insurance is becoming more common in middle market transactions but this is still not standard practice.
Working with a good M&A attorney and advisor is paramount to ensuring the Reps and Warranties section is written fairly and correctly.
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