Reps and Warranties

Reps and Warranties are statements of facts or assertions made by the seller (business to be acquired) to the buyer (the acquirer) to understand and enter into a contract where the facts may be related to the past or present status of the business. An indemnity agreement or bond supports these if any of the facts disclosed are false.

The reps and warranties clause in a purchase agreement states the facts about the assets, liabilities, operations, and a detailed account of the business in its current form and the historical data about the same. Subsequently, based on the contents of this document, negotiations, and sorting of the risk between the two parties are carried out.

• Reps and warranties are truth or statements by the seller to the buyer to know and make a contract with precise details concerning the business's past or present status. If any facts disclosed are false, an indemnity agreement or bond supports it.
• Organization, authority and qualification, capitalization, financial statements, and property title are examples of reps and warranties.
• It is a vital M&A agreement component, so professionals and advisors are hired. Moreover, it also helps all the clauses be legally conducted and entered to ensure security for both parties entering the contract.

Reps and warranties provide the assertion of the fact for closing the deal of sale of the business and repay all the statements of facts and provide the mitigation of losses that may occur in the future of the business. It is one of the essential parts of an M&A agreement for which professionals and advisors are hired for the job.

 It helps all the clauses be legally held and entered into to provide security to both parties entering into the contract.

These documents are drafted by the seller assuring the buyer that the business or the product in question would perform at a specific rate. The reps and warranties insurance provides the parties involved to hedge their risk if the terms of the agreement are not met at a future date.

Before acquiring any business, the buyer would require a detailed account of the business’s current and past state to scrutinize the data and make the decision of investing their time and money into the organization.

Therefore, it is important to furnish details with utmost transparency to ensure both parties can derive maximum value out of the deal.

The reps and warranties clause would require the seller to provide the following information in the document for the buyer to understand the details of the business. Let us understand the intricate details of the concept through the examples below.

1. Organization: This clause provides that the organization is duly incorporated with the regulatory authority, validly existing, and in good relationship with the relevant government of a state or central.
2. Authority & Qualification: It provides that the organization is eligible for agreeing, and no consent is to be taken from any third party.
3. Capitalization: The acquirer verified the Cap Table shares issued and the amount paid against the relevant shares. The acquirer also verifies that there is no outstanding liability associated with capital like unpaid dividends.
4. Financial Statements: The acquirer ensures that the financial statement of the company shows the true and fair view of the organization’s business standings.
5. Title to Properties: It provides the list of assets and intellectual properties held by the company, and the company has a truthful title right over these assets. etc.

There are particular challenges faced during the recording of reps and warranties insurance and other related factors of the contract; some of them are as follows:

1. The facts and the cases to be recorded for the warranty clause are too wide, and some standard clauses like fraud misrepresentation may be included. Still, there is always a chance of missing some loopholes by either party, depending upon the competency of their legal advisor.
2. There may be misunderstandings or issues arising in bargaining as the facts claimed by the seller for the future of business in reps and warranties clause may be targeted for the next 1 to 2 years, but the buyer may want it for the long term like 4 to 5 years.

Let us understand the advantages of adding a reps and warranties clause to the purchase agreement through the explanation below.

• In the case of the agreement of purchase or sale of the business, the seller is the party who has all the knowledge regarding the business. Still, the buyer doesn't need to know the company or the business. Through Reps and warranties, the buyer gets the full disclosure of the business with the supporting documents which facilitate the transaction between the parties.
• The inclusion of the indemnification clause provides the mitigation over the risk of financial loss that may occur in the future of the business due to the omission of some facts by either of the parties or due to any falsified fact representation.
• It provides both parties' qualification to close the deal and provide a platform for mutual understanding. It provides both party's eligibility to fully fill their end of the bargain or agreement.
• It helps in applying or recording all the terms, conditions, and facts to be lawfully implied over the agreement.

Despite the advantages, there are factors from the other extreme of the spectrum that make acquiring reps and warranties insurance a hassle. Let us understand them through the disadvantages discussed below.

• It is a lengthy and time-consuming activity. It may take a substantial amount of time for both parties to agree on equal fitting where both parties have a win-win situation.
• It cost both parties as both parties had to hire a competent law consultant to close the deal so that all the relevant lawful clauses are taken into account.
• The clauses related to warranties are common and so lengthy that there is a chance that both parties miss any loophole in the agreement that one can benefit from.

Let us understand the differences between representations and warranties within the reps and warranties clause through the comparison below.

• A Representation is a statement of facts provided by the buyer as an assertion to induce the buyer to make the contract. In contrast, warranties provide the indemnity clause in breach of contract or trust in the representation part.
• Representation is the materialization of facts and figures regarding the target company, which may relate to the present or past of the company. In contrast, warranties provide the remedy clause for future loss if occurred due to the omission of any relevant facts by either party to the contract.

This article has been a guide to What are Reps and Warranties. Here we explain its examples, challenges, advantages, disadvantages, and compared reps and warranties. You can learn more about from the following articles –

• Types of Mergers and Acquisitions
• Mergers and Acquisitions Career
• Reverse Merger