M&A Vocabulary – Explained by the experts: Reps & Warranties

In this ongoing series, a number of different M&A experts from the global offices of Rödl & Partner each present an important term from the English specialist language of the mergers and acquisitions world, combined with some comments on how it is used. We are not attempting to provide expert legal precision, review linguistic nuances or present an exhaustive definition, but rather to give a basic understanding or refresher of a term and some useful tips from our consultancy practice.

Within the context of a transaction, each of the parties has a different level of information: The vendor is generally well-informed about the condition of, and all the processes within the target company, while the buyer tries to investigate all the significant factors for him, and potential inherent risks when carrying out his due diligence.

During the due diligence process, the buyer relies on information provided by the vendor, since he has little or no possibility, prior to concluding the contract, of familiarising himself with the actual state of affairs in the target company or with other circumstances that are important to him in relation to concluding the transaction or not. Therefore, a list of “Representations & Warranties” typically forms part of the transaction contract.

As a rule, this list is created in the form of a conclusive enumeration covering the assurances and guarantees submitted by the parties, and excludes the exercise of any further statutory warranty rights.

In this list, assurances are normally provided in the following areas: 

• Ownership, right of disposal and lack of encumbrance for the ownership interest or shares in the target company
• Proper organisation of the target company, non-existence of insolvency conditions nor any threat of insolvency of the target company and the vendor
• Proper bookkeeping in accordance with the applicable legal provisions and accounting principles and standards, and processes in accordance with consistently applied principles, no material adverse changes since the date of the last balance sheet
• Proper preparation and timely submission of tax returns, full payment of tax amounts due and/or provisions for future amounts not yet due
• Title (possibly also the condition) of specific key operating assets
• Proper performance of significant contracts and no knowledge of plans to terminate by the other contracting parties, (if relevant, disclosure of all change of control clauses)
• Existence of the required commercial, environmental and other legal permits, no existence of legacy contamination or environmental risks
• Existence of all required intellectual property rights (ownership or license), no infringements of third party property rights, or infringements by third parties
• Full and correct disclosure of all employment law assets and employee pension contracts, no shortfall in the cover of company pension schemes, and adequate provisions for pension commitments
• No current or threatened legal disputes, other than any cases already disclosed
• Disclosed information and documents are accurate and complete, and are also not misleading.

The time at which the reps & warranties listed in the catalogue are to apply will be defined contractually by the parties, normally this is at least on the date of signing the contract and the date of completion of the transaction (“signing date” and “closing date”). If the accuracy of an individual assurance or of all assurances collectively is to be a prerequisite for completion, the buyer can refuse completion in the event of any breach of the assurance.

It is perfectly normal to qualify assurances by mere knowledge and to add the phrase “to the best of (our) knowledge”. In this case, it is important to correctly identify the person whose knowledge is decisive, as it is not always the vendor or his deputy who has operational responsibility within the target company, e.g. as a managing director. In addition, sometimes also the question is regulated of whether a party should have been aware, i.e. what duty of care should be imposed on the vendor, and whether negligent ignorance triggers a breach of this type of qualified assurance.

Finally, the vendor’s liability arising from the inaccuracy of an assurance is generally limited by the disclosed information and documents, which means that information that has been properly disclosed by the vendor allows him to limit or even completely exclude liability towards the buyer.

Otherwise, in the event of an assuranc being breached, a buyer will have warranty rights, whose scope and restrictions have also been contractually agreed. The same applies to arrangements regarding the assertion of claims, i.e. within what deadlines, in what form and to whom information concerning the existence of a breach must be submitted, within what deadlines and in what form a reaction and potentially relief must be provided, and to what claims the party who is alleging the breach of an assurance is entitled.

In practically all cases, the assertion of claims due to the inaccuracy of an assurance is time-limited. The claims themselves must exceed a certain minimum amount in order to be asserted at all (“de minimis”). In addition, they are generally limited in value (“capped”) and secured by retentions or bank guarantees. For known risks, and also risks whose value cannot to be estimated, exemptions (“indemnities”) can be agreed, such as for further future tax demands.