Representations and Warranties: Protecting Yourself in Business Sales

If you read last week's post on purchase agreement essentials, you know that representations and warranties are the factual statements each party makes about themselves and business as a condition of the deal. This week we are going deeper, because representations and warranties are where a significant amount of negotiation happens, and where a significant amount of post-closing disputes originate.

Seller often breeze through representations and warranties. This is a mistake. Take care in how you represent the condition of your business to a buyer.

Understanding what they are, how they work, and what to watch out for is essential for anyone buying or selling a North Carolina business.

What Representations and Warranties Actually Are

Representations are statements of fact made as of a specific point in time. Warranties are promises that those statements are true. In practice, the two are typically combined into a single section of the purchase agreement and treated together.

When a seller signs a purchase agreement, they are making binding statements about the business. Those statements form part of the foundation the buyer is relying on to close the deal and pay the purchase price. If those statements turn out to be false, the consequences can be significant. It is common for the seller’s owners to make those representations and warranties personally. 

What Sellers Typically Represent

Seller representations cover a wide range of topics. Common examples include statements that the financial statements are accurate and prepared in accordance with standard accounting principles, that there is no pending or threatened litigation or insurance claims that have not been disclosed, that the business owns or has valid rights to use all of its assets, that all material contracts are in full force and effect and have been disclosed, that the business is in compliance with applicable laws and regulations, that all taxes have been filed and paid, that all workers are properly classified and that there are no undisclosed liabilities of any kind.

Each of these representations is a specific factual claim. Each one creates potential liability if it turns out to be inaccurate.

What Buyers Typically Represent

Buyer representations are generally narrower. They typically include statements that the buyer has the legal authority to enter the transaction, that doing so does not violate any other agreement the buyer is bound by, and that the buyer has the financial ability to fund the purchase price. In some deals, particularly larger ones, buyers may also make representations about their financing arrangements.

Why the Specific Language Matters

The drafting of representations and warranties is your lawyers earns their fees. Small differences in language create big differences in exposure.

Sellers typically push to limit their liability to things they actually knew about. A representation that there is no pending litigation is very different from a representation that to the seller's knowledge there is no pending litigation. Buyers push back on those qualifiers because they want the seller to be accountable for the actual state of the business, and what a reasonable seller should know, not just what the seller claims to have known.

Materiality qualifiers work similarly. A representation that there are no material breaches of contracts is narrower than a representation that there are no breaches at all. What counts as material becomes a point of negotiation and, sometimes, a point of dispute.

Disclosure schedules are another critical piece of this puzzle. Sellers disclose exceptions to their representations on schedules attached to the agreement. A representation may state that there is no pending litigation except as set forth on Schedule 3.12. What goes on that schedule, and how it is described, matters enormously.

How Representations Connect to Indemnification

Representations and warranties do not stand alone. They connect directly to the indemnification provisions we discussed last week. If a representation turns out to be false, the buyer's remedy is typically an indemnification claim against the seller for the losses that resulted.

The survival period determines how long after closing the buyer can bring that claim. Heavily negotiated provisions often survive for 18 to 24 months after closing. Fundamental representations, such as those covering ownership of the business and authority to sell, often survive indefinitely. Fraud claims typically have no survival limit.

A Word to Sellers

Sellers sometimes treat representations and warranties as boilerplate to get through quickly. That is a mistake. Every representation you make in a purchase agreement is a potential source of post-closing liability. Before you sign, you need to know that every statement you are making is accurate, that your disclosure schedules are complete, and that you understand what you are on the hook for if something surfaces later.

Getting that right is not just about the closing. It is about what happens in the months and years after the deal is done.

Legal Direction works with North Carolina buyers and sellers to negotiate representations and warranties that reflect the actual risk allocation of the deal and protect our clients on both sides of the table. Reach out today to schedule a consultation.