What are 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 come into an understanding and enter into a contract where the facts may be related to the past or present status of the business. These are supported by an indemnity agreement or bond in case of any of the fact disclosed are false.
Example of Reps and Warranties
Some of the representation and warranties that an acquirer will ask of the company to be acquired to mention or include in the agreement are as follows:
- Organization: This clause provides that the organization is dully incorporated with the regulatory authority, validly existing, and in good relationship with the relevant government of a state or central.
- Authority & Qualification: It provides that the organization is eligible for entering into the agreement, and no consent is to be taken from any third party.
- Capitalization: The acquirer verified the Cap Table and receive the information regarding the number of shares issuedShares IssuedShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet. and the amount paid-up against the relevant shares. The acquirer also verifies that there is no outstanding liability associated with capital like unpaid dividends etc.
- Financial Statements: The acquirer ensures that the financial statement of the companyFinancial Statement Of The CompanyFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. shows the true and fair view of the organization’s business standings.
- Title to Properties: It provides all the list of assets and intellectual properties held by the company, and the company has a truthful title right over these assets. Etc.
Challenges of Reps and Warranties
There are particular challenges faced during the recording of reps and warranties related to the contract; some of them are as follows:
- The facts and the cases to be recorded in for the warranty clause are too wide, and maybe some standard clauses like fraud, misrepresentation may be included. Still, there is always a chance of missing some loopholes by either of the party depending upon the competency of their legal advisor.
- There may be misunderstanding 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.
Difference between Representations and Warranties
- A Representation is a statement of facts provided by the buyer as an assertion to the facts 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 of the party to the contract.
Benefits of Reps and Warranties
The following are the benefits of the Reps & Warranties in the contract of sale or purchase of the business:
- In 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, it is not necessary that the buyer has knowledge regarding 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 party.
- The inclusion of the indemnification clause provides the mitigation over the risk of financial lossRisk Of Financial LossFinancial risk refers to the risk of losing funds and assets with the possibility of not being able to pay off the debt taken from creditors, banks and financial institutions. A firm may face this due to incompetent business decisions and practices, eventually leading to bankruptcy. that may occur in the future of the business due to the omission of some facts by either of the party or due to any falsify fact representation.
- It provides the qualification of both the party to close the deal and provide a platform for mutual understanding. It provides both party’s eligibility to full fill their end of the bargain or agreement.
- It helps in the application or record of all the terms, conditions, and facts to be lawfully implied over the agreement.
Disadvantages of Reps and Warranties
There are certain disadvantages linked together with the reps and warranties regarding a merger & acquisition agreement:
- It is a lengthy and time-consuming activity. It may take a substantial amount of time for both parties to come into an agreement of 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 accord into the agreement.
- The clauses related to warranties are common and so lengthy that there is a chance that any loophole is missed by both the party into the agreement that one can take benefit of.
Reps and warranties provide the assertion of the fact for closing the deal of sale of the business and indemnify 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 to be legally held and entered into to provide security to both parties entering into the contract.
This article has been a guide to What are Reps and Warranties. Here we discuss the example and challenges of representations and warranties along with its benefits, disadvantages, and differences. You can learn more about from the following articles –