In the world of mergers and acquisitions (M&A), the devil is often in the details. Whether you are acquiring the entire shareholding of a company or purchasing specific business assets, one of the most critical legal features of the transaction document is the section dealing with representations and warranties. While often bundled together, representations and warranties serve distinct purposes and are central to managing the risks associated with the transaction. They help to ensure that the buyer is acquiring what it believes it is paying for, and they serve as the foundation for post-closing remedies if things go wrong. In both share purchase agreements (SPAs) and asset purchase agreements (APAs), reps and warranties provide the parties with clarity, assurance, and recourse.
What Are Representations and Warranties?
At a basic level, representations are assertions of fact made by one party (usually the seller) about the past or present state of affairs concerning the business being sold. These statements are intended to induce the other party (usually the buyer) to enter into the agreement. Warranties, on the other hand, are promises that such statements are true and accurate. If a representation turns out to be false and the buyer suffers loss as a result, the buyer may be entitled to claim damages. In some jurisdictions and legal traditions, the distinction between representations and warranties has meaningful implications for the remedies available, while in others the two terms are treated interchangeably.
In an M&A context, the representations and warranties typically cover a wide range of areas, including the seller’s title to the shares or assets, the financial statements of the business, compliance with laws, material contracts, litigation, intellectual property, employment matters, tax liabilities, and environmental issues. They form the factual matrix on which the buyer relies to make a well-informed decision.
Role in Share Purchase vs. Asset Purchase Agreements
While the function of reps and warranties is generally consistent across transaction types, the nature of what is being warranted differs depending on whether the deal is structured as a share purchase or an asset purchase.
In a share purchase agreement, the buyer is acquiring the company as a whole, including all its assets, liabilities, and corporate structure. Here, the representations and warranties tend to focus on the corporate status of the target company, its subsidiaries, capitalisation, ownership of shares, financial condition, legal compliance, and undisclosed liabilities. Since the buyer is stepping into the shoes of the shareholder, it inherits all the risks associated with the company—both known and unknown. This makes reps and warranties particularly crucial, as they are the primary mechanism for identifying and allocating these risks.
By contrast, in an asset purchase agreement, the buyer acquires specific assets and may assume certain liabilities, often on a negotiated basis. As a result, the reps and warranties in an APA tend to be more granular. They will cover title to each asset, any encumbrances or liens, and the assignability of contracts. The seller may also be required to provide information about inventory, machinery, customer and supplier relationships, intellectual property, and outstanding orders. Because the buyer is not acquiring the entity itself, there is often less concern about matters such as corporate governance or share ownership, and more focus on the physical and contractual attributes of the specific assets being transferred.
Purpose and Importance of Representations and Warranties
Representations and warranties serve several important functions in M&A transactions. First and foremost, they provide disclosure. By requiring the seller to make detailed factual statements about the business, they force a level of transparency that helps the buyer perform its due diligence. Any exceptions or qualifications to the reps and warranties are typically disclosed in a disclosure schedule, which becomes part of the agreement and provides a record of what was known or accepted by the buyer at the time of the transaction.
Second, reps and warranties are a tool for risk allocation. In essence, they help determine who bears the cost if certain assumptions turn out to be incorrect. For instance, if a seller represents that the company is not involved in any litigation, but it turns out post-closing that a lawsuit had been filed and not disclosed, the buyer may seek compensation. The extent of liability will depend on the terms of the agreement, including any caps, baskets, and survival periods, but the representation gives the buyer a clear basis for a claim.
Third, they provide a legal basis for remedies. Without representations and warranties, a buyer may be left to rely solely on common law remedies such as misrepresentation or breach of contract, which can be harder to prove. Including detailed and negotiated warranties in the agreement streamlines the process for post-closing disputes, often limiting them to breach of warranty claims governed by contract law rather than tort.
Fourth, the process of negotiating reps and warranties promotes contractual clarity and commercial alignment. It compels the parties to confront and resolve uncertainties, ambiguities, and discrepancies before closing. This reduces the likelihood of disputes arising after the deal is completed and increases the likelihood of a successful integration.
Common Representations and Warranties
Although the specifics vary from deal to deal, some of the more common representations and warranties include:
- Authority and Capacity: The seller has the authority to enter into and perform the agreement.
- Title to Shares or Assets: The seller owns the shares or assets free and clear of encumbrances.
- Financial Statements: The financial statements are accurate and fairly present the financial position of the business.
- Absence of Material Changes: There has been no material adverse change in the business since a specified date.
- Compliance with Laws: The business complies with applicable laws and regulations.
- Litigation: There are no current or threatened claims or investigations.
- Contracts: All material contracts are valid, in good standing, and not in default.
- Tax Matters: All taxes have been paid and returns properly filed.
- Employees and Benefits: Employment practices and benefit plans are in compliance with the law.
The specific representations will be heavily negotiated based on the due diligence findings, bargaining power of the parties, and risk tolerance.
Tying to Indemnities
Representations and warranties often form the basis for indemnity provisions in the agreement. The indemnities set out the process by which a party (usually the buyer) can claim compensation if any of the reps and warranties are found to be untrue. These clauses are typically subject to negotiated limitations, such as time limits for bringing claims, minimum thresholds (baskets), maximum recovery amounts (caps), and exclusive remedy provisions. Buyers and sellers must be careful to align the indemnity framework with the scope of the reps and warranties to ensure a coherent and enforceable risk allocation structure.
Conclusion
Representations and warranties are much more than legal boilerplate—they are the backbone of risk management in M&A transactions. They provide the buyer with a snapshot of the business being acquired and give the seller an opportunity to limit liability through disclosures and negotiated qualifications. While the process of drafting and negotiating these provisions can be time-consuming, their importance cannot be overstated. They not only shape the contours of the transaction but also form the basis for enforcement and dispute resolution post-closing. In this way, they serve both as a sword and a shield in protecting the interests of both parties in a deal.
When structured correctly and supported by comprehensive due diligence, representations and warranties help foster trust, reduce uncertainty, and provide a reliable framework for remedy. For any business considering an acquisition—whether by shares or by assets—understanding and negotiating these provisions is not just good legal housekeeping, it is essential deal hygiene.