Reps and Warranties

What Does Reps and Warranties Mean?

Reps and warranties is a term used to describe the assertions that a buyer and/or seller makes in a purchase and sale agreement. Both parties are relying on each other to provide a true account of all information and supporting documents to close the transaction.

The seller's representations usually relate to the information that the buyer is relying on to value the company. Therefore, the seller ends up not only stating that all financial information provided is true and accurate, but also having to deliver information to support this statement such as financial statements, customer and supplier listings, copies of all major contracts, equipment listings, etc. This information all forms part of the schedules to the purchase and sale agreement, and may be referred back to post transaction to ensure that what was effectively purchased truly does exist.

The buyer's representations usually relate to the form of consideration being used to complete the transaction. If the buyer's stock is part of the transaction consideration, then the buyer must represent that it is legally able to offer this stock. In addition, the buyer must provide a shareholder agreement for the seller to review and state that the stock is being offered free and clear of any encumbrances.

Divestopedia Explains Reps and Warranties

Reps and warranties form the basis of due diligence for buyers. Essentially, they provide an opportunity for the seller to disclose any potential issues with the company prior to completing the transaction. For example, if a contract with a significant customer that has been included in the valuation is about to expire, the seller is obligated to disclose this expiry as part of its reps and warranties. Not disclosing a material circumstance like this would potentially keep a transaction from closing or trigger a legal dispute post-transaction.

To mitigate the risk of financial loss from either party not representing something significant, purchase and sale agreements usually contain an indemnification clause. This clause protects the other party from an ommited or missed representation which may lead to a post-transaction financial loss. Therefore, it is important that both parties provide all information up front in their reps and warranties to avoid costly legal disputes trying to enforce indemnification clauses.