Yes, the Representations and Warranties in a Purchase Agreement DO Matter
James Smith was ready to sell his business. He received his purchase agreement from the buyer and agreed on the terms, however there were pages and pages of representations and warranties. He figured this was standard procedure and didn’t think twice about it or inform his attorney.
After James and the buyer signed the agreement, the buyer decided he paid too much for James’ business. He used the language in the representations and warranties to threaten to sue James unless he cut the price of payment. And according to the language in the representations and warranties, the buyer was within his rights to do so.
When selling a business, a smart owner will do everything necessary to limit risk. This is especially true with representations, warranties and indemnities. Although sellers can look at these aspects of the selling contract as boilerplate language, they are incredibly important. If they aren’t crafted specifically to fit the seller’s needs and minimize risk, the buyer can always use their advantage to sue for damages or cut the sale price when the seller believed it was a done deal!
Representations and warranties. Crafting accurate representations lays the foundation for a solid legal document. If the buyer finds any misrepresentations or is not satisfied with the representations a business sets forth, they can walk from the deal or, even worse, come back after the fact and sue for damages. A good selling contract will have detailed and accurate representations of intellectual property, existing contracts, previous or current litigation, employees, customers, and tax issues, among many other considerations.
Disclose. The representations and warranties portion of a purchase agreement can be the most tedious section of the process. But disclosure is a crucial part of protecting the seller’s interests, and sellers must make all necessary disclosures. This is not the place to cut corners. A good seller will get involved in the disclosure process and fully understand what the disclosures say about their business. This section isn’t just legal language tinkering, but has the potential to make or break a sale.
Indemnities. An indemnity is simply a promise to reimburse the buyer if a specific set of circumstances are met. If a buyer finds that a seller has misrepresented any aspect of their business in the selling contract, then they can sue for damages. So, if a seller misrepresents customer information or under-reports tax burdens, a buyer can show a breach of warranty and demand payment equal to their losses due to misrepresentation.
Set Limits. A smart seller can reduce their risk by reducing the limits on indemnities as much as possible. This would include keeping the term of the indemnity short to keep buyers from coming back years down the road and restricting the types of damages the buyer can recover. So, instead of a 4-year term on tax claims, you and your lawyer could set, say, a 2-year term on environmental claims and completely remove the possibility for tax claims. Setting good limits reduces the chance that the buyer can bring legal action against a seller.
Good sellers protect themselves from frivolous lawsuits and massive headaches by using an experienced attorney with the knowledge to craft a proper document, but also by being involved in the process and knowing where they can help to limit their risk.