The exchange of relevant business information between parties plays a crucial role for the success or failure of any Mergers and Acquisition (“M&A”) or Private Equity (“PE”) deal. Both parties, especially the buyer, rely on the authenticity of such information for closing the deal. In this context, the role of representations and warranties is critical for determining the rights and liabilities of the parties to a transaction.
For instance, the buyer may later find out that one of the seller’s warranties i.e. “grant of a large contract in favour of the target company” or “certain ongoing regulatory investigations will not have any significant impact on business” is untrue, and therefore the value of the business has diminished as of today, from what was represented to him at an earlier point of time during negotiations. That’s where the representations and warranties (“Reps and Warranties”) come into play.
There have been notable cases in India where breach of Reps and Warranties have played a significant role. As recent as in March 2018, Reliance Infrastructure issued a legal notice to Pipapvav Defence and Engineering for a claim of breach of warranties amounting to a significant amount of INR 5440.38/- crores [approximately US$75 million]. It is evident that in commercial contracts, Reps and Warranties have huge implications for businesses.
It is well established that, generally used, (a) representations are factual statements of past or existing facts, and (b) warranties are contractual statements that existing or future facts or events are or will be true. This understanding is supported by the provisions of Section 17–19 of the Indian Contract Act, 1872 (“ICA”) and Section 12 of the Sale of Goods Act.
Despite the above, most modern drafting practices tend to club “Reps and Warranties” together as a single clause. However, considering the difference in the remedies available for breach of representations or breach of warranties, both parties need to understand the implications of entering into such a contract. Here is a guide to the same: –
1) Scope of Reps and Warranties in M&A and PE
Reps and Warranties in a typical M&A and PE deal act as “inducements” by the seller to the buyer to enter into the contract. This requirement of stating often “routine” requirements as Reps and Warranties are important, as “Caveat Emptor” applies in the ICA to a limited extent and silence about a particular fact is not necessarily fraud in Indian law.
Hence, in M&A and PE deals, a representation by the seller will state the past or existing state of affairs of the concerned business, whereas a warranty may go a step further and assert the current and future affairs of the business, including events that may take place post-execution of the contract.
2) Effect of breach of Reps & Warranties
3) “Represents and warranties” — A case for clarity?
As the implications of breach of representations and warranties itself are different, especially from a seller’s perspective, it will be better to differentiate between Reps and Warranties. If this is not done through separate clauses due to the prevalence of a “clubbed clause” in commercial contracts as of today, then, through precise drafting to communicate the intent of both parties. This will help to minimize uncertainty in the scope, interpretation and application of Reps and Warranties before courts.
On the other hand, from a buyer’s perspective, their conduct during the due diligence, subject to the facts and contractual provisions drafted in the particular case, may lead to a dilution of the Reps and Warranties [Infinite land Ltd. v. Artisan Contracting Ltd (2005 EWCA Civ 791)]. Therefore, a differentiation of the Reps and Warranties will help to seek the protection of Representations/ Warranties that are outside the scope of the disclosure letter. However, this needs to be balanced with the advantages a buyer may get from the ambiguous usage of “Seller represents and warrants that…”, which may allow the buyer to pursue a wider set of reliefs before the courts.
Hence, the apportionment and usage of Reps and Warranties in M&A and PE transactions needs to be carefully inserted in each transaction, depending on the interests, objectives and certainty that parties wish to impart into a contract.
Finally, the parties can opt for an “M&A / PE Rep and Warranty insurance contract”, so that the buyer can mitigate and outsource (certain) risk(s) of breach thereof to a third party (Insurance Company), as well as keeping a well-drafted “Entire Agreement” clause to ensure courts will seek for interpretation tools within the contract itself.
A follow-up on some crucial interpretation clauses that can be inserted in future M&A / PE contract, in light of recent Indian judgments, will be taken up in a future post.