Problem: the seller is under no legal obligation to disclose liabilities of the company to the buyer.
Solution: the buyer requires the seller to make representations and warranties about the company. If the representation is inaccurate or the warranty is breached, then the seller is required to indemnify the buyer.
A representation, commonly referred to as a “rep” in Reps and Warranties, is an assertion of fact made by the seller to induce the buyer to enter into the purchase agreement. These representations assure the buyer that key aspects of the business being acquired are as described. If a representation is found to be untrue, it is considered “inaccurate,” potentially leading to claims under the warranties section of the agreement. The accuracy of Reps and Warranties is crucial in mitigating risks in M&A transactions.
A warranty is a promise of indemnity if the assertion is false. If a warranty is not true it is “breached.”
Indemnification is when the seller compensates the buyer for its financial loss that resulted from the inaccurate representation or breached warranty.
The purchase agreement will have three finance-related representations and warranties.
(1) Financial Statements. As part of the Reps and Warranties, the Company represents and warrants that it has provided the Buyer with accurate financial statements. These financial statements have been prepared from the Company’s books and records and are in compliance with generally accepted accounting principles (GAAP), consistently applied. The Company further warrants that these financial statements fairly present its financial position as of the specified dates, ensuring transparency and reliability in accordance with the terms of the agreement.
(2) Absence of Undisclosed Liabilities. The Company has no liabilities or obligations except for liabilities reflected or reserved against in the financial statements.
(3) Taxes. The Company represents and warrants that it has timely filed all required tax returns, which are accurate and complete in all material respects. All taxes due have been fully paid. No tax deficiencies have ever been proposed or assessed against the Company. Additionally, none of the Company’s federal income tax returns, nor its state income, franchise, or sales and use tax returns, have ever been audited by any governmental authority.
Also read: Maximizing Your After-Tax Proceeds
