Sample Representations and Warranties

Buying and selling a small business is no different than any commercial sale. The seller must provide the buyer with a statement of value about the company. The buyer or their agents must conduct due diligence to verify all claims about the company before the sale. Then, the parties can begin negotiations.

Representations and warranties often get litigated after a purchase or merger. Any failure to disclose a fact or an error in the wording of the representation and warranty can lead to legal action.

Whether you are the buyer or seller, you must carefully negotiate your representations and warranties. This article discusses representations and warranties and offers sample language for your purchase agreement.

What Are Representations and Warranties?

During negotiations for the purchase agreement, the parties discuss representations and warranties ("reps and warranties"). These phrases usually appear together in an agreement. Both parties must give representations and warranties, although the seller will give more than the buyer.

A representation is a statement of fact that is true to the best of the maker's knowledge on the effective date of the representation. For instance, "Seller represents that Seller has the authority to transfer this company."

A warranty gives the buyer indemnification if the representation is false. If the seller doesn't have the authority to transfer the company, the buyer can sue the seller and the company at the company's expense.

Representations and warranties "survive" the closing date. That is, the clauses continue to have full force and effect post-closing. It's in the seller's best interests that all representations be accurate so the buyer does not need to litigate once the sale is complete.

The seller can also ask for representations and warranties from the buyer. Buyer representations are typically about authority to buy and having enough capital.

Baskets, Caps, and Qualifiers

Since representations and warranties require the seller to guarantee knowledge of all facts about the sale, most purchase agreements limit the amount or duration of "knowledge." This prevents the seller from being responsible for things they may not be aware of and keeps the total indemnity below a set amount.

Knowledge qualifiers depend on the seller's specific knowledge of the representation made. A knowledge qualifier may include a definition of "knowledge" in the contract.

Sample language: "To the best of seller's knowledge," "To seller's actual knowledge," "To seller's knowledge at the time of this agreement."

Survival periods limit the duration of clauses in the agreement. Representations are time-limited. For instance, representations about intellectual property typically last about 36 months. Tax compliance knowledge may last twice as long because the seller should know if the company has paid its taxes.

Sample language: "Representations and warranties made by Seller shall survive 18 months past closing, except [exceptions or exclusions]."

Baskets, or minimums, are the number of claims a buyer must accept before indemnification. Like an insurance deductible, baskets protect the seller by forcing the buyer to bear some disputes' costs.

Sample language: "Seller will not be liable to Buyer until the total amount of damages exceeds [percentage of purchase price] or [dollar amount], whichever is greater."

"Seller will not indemnify Buyer until all damages exceed [dollar amount]. Seller is liable only for damages under [Section X] or that occurred prior to [date]. Seller is not liable for any breach or damages under [Section Y] or that occurred after [date]."

Caps set a maximum dollar amount for seller liability. Once the value of claims reaches the cap, the seller is no longer liable to the buyer.

Sample language: "The total amount of damages Buyer may recover in any action arising from or in connection to a breach of these representations and warranties shall not exceed [dollar amount]."

Disclosures and Exceptions

The seller must attach a disclosure schedule to the purchase agreement. It may also be part of the agreement itself. The disclosure schedule contains all the seller's representations and any exceptions and exclusions.

Disclosure schedules follow the purchase agreement. Sellers should begin work on the disclosure schedule and update it during negotiations. It will include such items as:

• Material contracts with other businesses
• Leases, including lease payments, type of lease, duration
• Intellectual property, such as trademarks, patents, and copyrights
• Software licenses, including open-source use
• Company assets and liabilities
• Financial statements

Sellers must list any pending litigation or outstanding judgments in the schedule. Exclude anything that the buyer will not be liable for.

Sample language: "[Seller] has prepared Disclosure Schedule in accordance with Purchase Agreement dated [date] between [Seller] and [Buyer]. Terms not defined in this Disclosure Schedule have meanings previously agreed upon in the Purchase Agreement "Definitions" clause.

"Disclosure Schedule contains qualifications, exclusions, and limitations by reference to provisions in the Purchase Agreement. Inclusion of additional information herein shall not be construed as an admission that such information is material to the business, financial condition, or operation of the business, except to the extent that the Purchase Agreement requires such information for a particular section.

Additional matters set forth in these schedules are set forth for informational or continuity purposes and are not necessarily required by the Purchase Agreement to be contained herein.

Headers are inserted for reference only and do not affect the contents of the Disclosure Schedule or the Purchase Agreement.

Writing the Representation and Warranty

Most purchase agreements contain a general representation and warranty clause at the beginning. This clause states the seller's fundamental representations and general warranties in the agreement. It may include general indemnification provisions and confirm that all information in the agreement is true to the seller's knowledge as of the closing date.

Note that these samples are not exhaustive. Most purchase agreements are heavily negotiated, and you and your attorney should review each clause carefully. Remember that you promise everything you state in the agreement is true to the best of your knowledge and that you will insure the buyer against any breach of the agreement if what you say is wrong.

Sample language: Seller represents and warrants that all facts presented in this Purchase Agreement, including without limitation all financial statements and [other documents] attached hereto, are true and correct in all material respects as of the Closing Date [date] of Purchase Agreement.

Seller further agrees to fulfill all indemnification obligations to Buyer as described in [indemnification clause] in the event of breach of any disclosure in this Agreement.

Each section of the purchase agreement may have an in-line warranty. This helps protect the seller in specific clauses and statements in the agreement. A buyer may request an extensive list of representations from a seller, and a blanket representation and warranty may not give you the security you'd like.

Sellers may want representation and warranty statements for each section of the purchase agreement.

Sections and sample language:

Assets (Title, Condition, Liens, Etc.)

Seller warrants [asset] is owned free and clear of all liens, encumbrances, notes, or claims. [Asset] is in good repair and regularly maintained.

Seller affirms and warrants that all inventory assets are unused and salable. Seller is not in default on any contract with vendors or customers.

Laws, Permits, Licenses, and Litigation

At Closing Date, Seller affirms there are no legal proceedings against Company. There are no outstanding judgments, claims, liens, or other legal action. Company is not a plaintiff in any ongoing litigation.

Company is in compliance with all applicable laws, permitting, zoning regulations for [state/county]. Company is in good standing with state and federal environmental regulators.

Financial Disclosures and Taxes

Seller affirms that all financial statements are prepared using generally accepted accounting principles (GAAP). Statements are complete and represent in all material respects Company's financial status. Financial statements are complete and accurate to the best of Seller's knowledge as of [date] of closing.

Seller affirms that Company is not delinquent in paying business or corporate taxes. and that employee income taxes are current as of [year].

Employees

Company has no employee benefit liability under ERISA. Seller has no knowledge of any current or pending union grievance [name union if relevant] or EEOC complaint. Seller agrees to advise Buyer of any material change in employee status between [date of agreement] and Closing Date.

There are no undisclosed consulting agreements, bonuses, outstanding employment contracts, or other third-party employment agreements to the best of Seller's knowledge.

General Warranties

Seller affirms Company is a [corporation/LLC] in good standing and is permitted to enter into this transaction without limitation.

Seller has disclosed all facts to Buyer that materially affect Company's condition, assets, operations, financial status, and liabilities. Seller represents and warrants that there are no material misrepresentations or omissions, intentional or accidental, that would affect Buyer's decision in this transaction.

Buyer's Representations and Warranties

The seller may also request warranties from the buyer. The buyer should warranty itself as a corporation in good standing with capital assets sufficient for the consummation of the sale. Sellers may also want the buyer to confirm that it did its due diligence.

Sample language: Buyer represents and warrants that all documentation requested in the ordinary course of negotiations has been provided to Buyer. Buyer has made an independent examination and analysis of the assets, Company, and financial statements. Buyer has completed an independent review of all materials provided by Seller and undertaken due diligence as Buyer deems sufficient.

Buyer has inspected [real property/tangible asset/inventory items] and finds property in adequate condition for purchase. Buyer agrees with valuation stated in Purchase Agreement [include price if relevant].

Get Legal Advice

Selling or buying a business puts a strain on any business owner. To protect all your rights, you must ensure you have covered every exchange of property and money in writing with the right promise and disclaimer. When you set out to sell or buy a company, contact an experienced contracts lawyer to negotiate your purchase agreement. Good business decisions are worth the cost.