5 Tips for Drafting Representations and Warranties for M&A Deals

Representations and warranties are more than just legal formalities in business mergers and acquisitions (M&A) and deserve careful attention when drafting and negotiating these terms. Representations and warranties are essentially statements made by each party (most importantly, Sellers) about the general state of affairs, including statements about the party’s financial health, assets, and legal compliance. Having well-drafted representations and warranties can reduce the risk of future disputes arising after closing and ensure the parties are on the same page.

Tip #1: Be Precise and Specific

When drafting representations and warranties, precision and specificity are key. Vague language included in representations and warranties can lead to misunderstandings and disputes post-closing. To avoid vague language, clearly define terms and concepts when drafting representations and warranties. For instance, if referring to the Seller’s “material contracts,” specify what “material” means in the context of the business. Additionally, use concrete figures and timeframes when possible, and avoid broad, undefined wording like “significant change” or “reasonable time”. Drafting representations and warranties with specificity can not only minimize ambiguity but also narrow the scope of what the Seller is responsible for, thereby reducing potential liability.

Tip #2:  Understand the Business

Understanding the Seller’s business is crucial for drafting effective representations and warranties. As part of the due diligence process, Buyer’s will learn the nuances of the Seller’s industry, the Seller’s position within the industry, and vital information about the Seller’s operations, financial health, liabilities, and assets. Representations and warranties should always be drafted to address the specific risks and realities of the Seller’s business, good, bad, or otherwise. For instance, when acquiring a tech company, Buyers may focus on intellectual property rights and data protection policies of the Seller, whereas when acquiring a manufacturing business, Buyer’s may focus on environmental compliance or contracts with key suppliers. Tailoring representations and warranties to the unique aspects of the Seller’s business ensures that all significant risks are adequately addressed with respect to the critical and most valuable components of the business.

Tip #3: Negotiate Materiality and Knowledge Qualifiers

Materiality and knowledge qualifiers can significantly impact the scope of representations and warranties. Materiality qualifiers can limit the Seller’s disclosure obligations to items or issues that would have a material impact on the business. Meanwhile, knowledge qualifiers can restrict the Seller’s representations to what they actually know or reasonably should know. Negotiating qualifiers requires balancing the Buyer’s need for information with the Seller’s desire to limit liability. Still, materiality and knowledge qualifiers are an excellent way to avoid disputes about what should have been disclosed and what constitutes a breach.

Tip #4: Encourage Disclosures

Representations and warranties should be drafted to encourage disclosures from the Seller. For example, if a Seller doesn’t actually own any of its equipment used in the business, including a representation and warranty requiring the Seller to list all equipment owned by the Seller will require the Seller to either disclose its lack of equipment ownership or render the failure to make such disclosure a breach of the agreement. Representations and warranties should also include comprehensive disclosure schedules where the Seller specifically lists key information about the business, such as the names of employees, its trademarks, contracts, assets, and liabilities. Disclosure schedules can also be used to allow Seller’s to make exceptions to general statements about the business, such as stating that Seller has filed all tax returns on time except for the 2017 and 2021 tax returns. Encouraging comprehensive disclosures can allow the parties to work together to address potential issues prior to closing and avoid last-minute discoveries that can kill the deal or result in litigation.

Tip #5: Plan for Post-Closing Problems

Representations and warranties should be drafted to plan for problems that arise after closing. Buyers and Sellers should identify how long each representation and warranty will survive after closing and set deadlines for raising disputes for misrepresentations or omissions. Buyers and Sellers should also identify dispute resolution mechanisms for breaches and clearly outline the conditions for any compensation and indemnification resulting therefrom. Planning for potential post-closing problems when drafting representations and warranties can help avoid disputes and achieve more cost-effective resolutions for all parties.

Conclusion

Drafting effective representations and warranties in M&A deals requires a blend of precision, business understanding, strategic negotiation, disclosures, and planning for post-closing problems. By focusing on these key areas, Buyers and Sellers can significantly reduce the potential for disputes over representations and warranties, ensuring a positive outcome for all parties. If you’re drafting representations or warranties for an M&A deal and need assistance, the attorneys at Jimerson Birr are here to help.