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Representations and Warranties Form the Bedrock of Private Acquisition Agreements

There are many provisions that are negotiated in almost all private acquisition agreements. Definitions, closing conditions, indemnifications, and representations and warranties are among the essential topics addressed by such agreements. While these topics all bear directly on the nature and value of a deal, the representations and warranties address a deal at its most basic level.

Representations and warranties create the base and framework upon which many of the other provisions rely; they form the basis for a buyer’s right to indemnification for problems or unforeseen risks and are integral to the closing conditions. Representations and warranties are usually the longest part of an acquisition agreement and often take a significant amount of time to negotiate. Given how important representations and warranties are, it is vital that all parties to a deal understand what they are and how they might be limited by a seller.

Representations and warranties are statements of fact and assurances made by the parties. The buyer and seller generally negotiate the scope of the representations and warranties, which might cover anything from the ownership status of assets to specific current and future liabilities to financial attributes of a part including creditworthiness. On the buyer’s side of the deal, the primary goal is to get comprehensive representations and warranties in order to ensure that the buyer’s knowledge of what is being purchased is as accurate and complete as possible.

Conversely, the seller generally prefers to give as few representations and warranties as possible. The seller also aims to limit the scope of the representations and warranties it has to give in order to add certainty and limit liability. The seller can limit the representations and warranties in at least five general ways.

First, the seller may wish to limit the scope of a representation or warranty to certain materials. For example, the seller may include only materials included on an attached list, specifically excluding any similar or related materials that do not appear on the list. This enables the seller to ascertain with relative certainty, prior to the close of the transaction, whether all of the contemplated materials conform and the scope of liability for any non-conforming materials.

Second, the seller may wish to address materiality by qualifying a representation or warranty by what is material or what might cause a material adverse effect. More importantly, how the parties define a “material adverse effect” is significant for the purpose of interpreting the application of qualifiers to the representations and determining whether a closing condition has been satisfied.

Third, the seller may address knowledge of the parties, especially the seller’s own knowledge. It is advantageous for the seller to define “knowledge” as actual knowledge to avoid costly investigations and eliminate uncertainty regarding the application of the standard. On the other hand, it is in the buyer’s interest to define knowledge constructively, indicating what the seller knew or should have known. By doing so, the seller will be deemed to know what it would have known had it conducted a reasonable investigation into the facts being represented.

Fourth, the seller may utilize time constraints to limit the applicability of any particular representation or warranty. This means the seller makes such a representation or warranty as of a specified date or time, or with respect to a particular period.

Fifth, the seller may choose to limit a representation or warranty by reference to disclosure schedules. These documents are often referred to simply as schedules, and they supplement the representations and warranties contained in an agreement. Schedules allow the disclosing party to list exceptions to the agreement and add information that is otherwise too lengthy or cumbersome to insert into the main agreement.

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