Negotiating Seller Reps and Warranties in a Purchase Agreement
One of the most heavily negotiated parts of a purchase agreement is often the seller’s representations and warranties – and for good reason. The seller’s reps and warranties serve three very important purposes in a purchase agreement: (1) they constitute what the seller is willing to tell the buyer as being true about the assets at the time of signing the agreement, (2) they are tested at closing when the seller needs to re-certify to the buyer that those same things are still true about the assets and (3) they can form the basis of an indemnification claim if the buyer discovers a problem after closing.
Let’s take each of those items one by one.
Reps and Warranties – While a seller might provide a buyer with a great deal of due diligence and financial and other information, the only things that the seller is standing behind are the representations and warranties actually included in the final signed purchase agreement. A buyer and seller have differing goals in this section of a purchase agreement, with the seller wanting to narrow its reps as much as possible, and the buyer wanting the broadest set possible. Keep in mind that just because an agreement proposed by a seller might include reps and warranties that go on for pages and pages, all those words might contain very little substance. In fact, a buyer-favorable set of seller reps can be concise and still give the buyer all of the protections it needs (and without scaring a seller by presenting an inordinate amount of reps).
The meat of the seller reps is the detail on each of the specific categories of assets being acquired – FCC licenses, personal property, real property, contracts and intangible property. The seller’s financial rep should be closely reviewed by the buyer’s CFO and should cover the financial statements that the seller provided. The seller should also provide a sufficiency rep on the assets. Any buyer should of course be wary of a seller presenting an “as is” deal, unless the buyer specifically agreed to that atypical structure.
Bringdown at Closing – When the purchase agreement is signed, the seller represents to the buyer that the reps are true on the date of signing. To give the buyer assurances that the assets and business are still essentially the same at closing as they were on the date the purchase agreement was signed and that the assets and business have not degraded, on the closing date the seller delivers a bringdown certificate to the buyer, certifying that the same set of reps and warranties are still true in all material respects. If there has been material changes in the assets, financials or other items covered by the specific set of reps the seller made in the purchase agreement, then the seller cannot make its bringdown or satisfy a closing condition. The buyer then has no obligation to close. Typically, deals don’t terminate at this stage and the parties work out a compromise like a purchase price credit.
Indemnification – The third circumstance in which the set of reps included in the purchase agreement is important is if the buyer discovers a problem with the assets or the financials after closing. In order to make a valid indemnification claim, the problem has to be a breach of one of the specific reps and warranties the seller made in the purchase agreement. If the problem isn’t addressed by one of the reps in the agreement, then it’s possible the buyer can’t make the claim. Typically, for indemnification purposes, the “in all material respects” language usually found in the bringdown isn’t in the indemnification section, since baskets, caps and survival periods are used to place limits on buyer indemnification claims.
Summary – The article containing the representations and warranties the seller makes to the buyer in a purchase agreement is one that is worth spending time to negotiate and clearly understand. The reps are not just meaningful for being a series of statements the seller tells the buyer about the assets, but also can trigger a failure of a closing condition or serve as the basis of an indemnification claim.