Representations and warranties are statements of fact made in the purchase agreement by the seller to the buyer.
If the seller’s representations and warranties are inaccurate, then the buyer will have an indemnification right under the purchase agreement.
An indemnification right means that if the buyer suffers a loss, then the seller will reimburse the buyer for the amount of the loss.
Example of indemnification: The seller represented that the company had no liabilities except for liabilities reflected on the balance sheet provided to the buyer. One month after the closing date, the buyer discovered a company credit card with a balance of $15,000. The seller forgot to include the credit card balance on the financial statements. The seller’s representation was inaccurate and the buyer suffered a loss of $15,000 when the buyer paid off the credit card balance. The seller is required to indemnify the buyer for the loss (i.e., the seller is required to pay the buyer $15,000).
The indemnification clause provides “the seller shall indemnify the buyer from losses incurred by the buyer resulting from any breach of any representation or warranty made by the seller.”
The representations and warranties and the indemnification rights work together to protect the buyer.
The buyer only has indemnification rights for so long as the representations and warranties survive the closing.
The buyer’s indemnification rights expire when the representations and warranties expire.
The purchase agreement provides how long the representations and warranties will survive the closing.
The buyer wants the representations and warranties to survive the closing forever. The seller wants the representations and warranties to survive the closing for as little time as possible.
The best day of a seller’s life is the closing date. The 2nd best day of a seller’s life is the day the representations and warranties expire.
Experience
The buyer wanted the representations and warranties to survive forever.
The seller wanted the representations and warranties to survive for one year.
The buyer and the seller were in a deadlock.
I suggested the following:
I made a list of the representations and warranties that were most important to the buyer. I titled these “fundamental representations”.
The fundamental representations included the following representations and warranties:
Organization
Authority
Title to Shares
Capitalization
I made a list of the representations and warranties that were important to the buyer due to a time element. The “Tax” representation was the only representation and warranty included in this category.
I suggested that the fundamental representations would survive the closing forever.
I suggested that the Tax representation would survive for three years.
I suggested that all other representations would survive for one year.
