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  • Cristina Lefter

M&A Concepts: “Representations and Warranties”

Updated: Jul 6, 2023

In all sale purchase agreements (SPAs), whether it is a transfer of shares in a company (share deals) or business (asset deals or business transfer agreements), there is a section entitled "Representations and Warranties", often translated in Romanian as "Declarații și Garanții". In Anglo-Saxon law, "Representations and warranties are clauses in the definitive merger agreement that establish the required condition of the buyer and the target firms at the time of signing the agreement, and again at closing. Failure to meet these conditions will usually trigger a renegotiation of price, or even cancellation of the deal."[1] The nuance between the two concepts can be summarized as follows: "A representation (or “rep”) is a statement of fact; a warranty is a commitment that a fact is or will be true. Together, these present a profile of the target (…) at the date of the transaction."[2]

From the perspective of Romanian law, the distinction between the two is not necessarily one of substance, since both the reps and the warranties are in fact guarantees of the seller in respect of (simply put) the company that is the object of the sale.

This comprehensive list of guarantees takes into account not only the subject matter of the sale per se (which, by assumption, represents the shares in question), but the state of the company as a whole. In practice, from the perspective of the Romanian Civil Code, the seller's guarantees in respect of the shares that are the subject of the sale would be limited to the guarantee for eviction (guarantee that the seller is indeed the owner of the goods that are the subject of the sale) and the guarantee for defects (guarantee that the shares were legally issued/subscribed etc.), without the seller guaranteeing in any way the substance of these shares i.e. the business that is taken over following the sale. Therefore, reps & warranties are required to add guarantees by the seller with regard to the value actually conveyed by the transfer/sale of shares/business/goodwill.

Reps & warranties are also a contractual risk allocation tool between seller and buyer, being closely linked to the due diligence process (legal analysis carried out on the target company) and to the disclosure of information by the seller carried out either as part of the due diligence or separately via a disclosure letter (concepts to which we will refer in later articles).

How does this contractual risk allocation work? According to the Romanian Civil Code (art. 1707 para. 4), the seller does not owe a guarantee against defects that the buyer was aware of when the contract was concluded. In other words, the seller cannot be held liable for those defects which, in the contractual understanding of the parties, are deemed to be known by the buyer because they were [fairly] disclosed during the due diligence process. This is in fact a qualification of reps & warranties, which could be interpreted (by way of example) as follows: the seller is liable for matters relating to the condition of the company under a warranty provided that those matters which may diminish the value of the target company or which may create damage to the buyer have not been disclosed to the buyer in a full and fair manner and in sufficient detail to enable the buyer to identify the nature and implications of the matter disclosed (fully and fairly disclosed).

Another example is qualifying reps & warranties by reference to the seller's knowledge. An example of such a clause would be: the seller warrants that, to its/his/her knowledge, the company is not in a position not to perform fully and adequately its obligations towards any of its contractual partners.

The above examples represent reps & warranties qualifications inspired by Anglo-Saxon law but operating under Romanian law with an important nuance. According to Art. 1708 para. (2) of the Romanian Civil Code, "a clause which removes or limits liability for defects is void in respect of defects which the seller knew or ought to have known at the time the contract was concluded". Therefore, Romanian law does not allow for a qualification of reps & warranties by reference to the seller’s knowledge (usually with respect to the object of the sale i.e. shares) to lead to the complete exoneration of the seller from liability for defects she/he/it knew or should have known, but at most to the exoneration from liability for defects she/he/it did not know (and - our addition - was not obliged to know).

In addition, according to the Civil Code, the guarantee for hidden defects also applies when the goods sold do not correspond to the qualities agreed by the parties (Article 1714 of the Civil Code). In other words, the parties can contractually agree that certain characteristics of the target company are "agreed qualities", with the consequence that the limitations agreed by the qualifications in reps & warranties will be removed (or rendered ineffective) by the mandatory provisions of the Civil Code which oblige the seller to be liable for hidden defects even if she/he/it was not aware, but should have been aware of them. The qualification of certain characteristics as "agreed qualities" is usually the result of the buyer's insistence, precisely to obtain the impossibility of exemption from liability for defects which the seller knows of or ought to have known of.

How can such a legal provision be handled from the seller's perspective in the SPA? We believe that full and fair disclosure of all information concerning the target company prior to signing the SPA is the most effective way to limit the seller's liability, as the buyer will not be able to raise a claim for a defect which was made known (or is considered to be made known) in the context of the due diligence process. It should be noted here that the notion of "knowledge of the buyer" is again debatable, as its content can be contractually defined (e.g. it can be the actual knowledge of certain persons in the buyer's management or in the transaction team). If, however, the buyer insists on retaining the right to compensation for a defect that has been disclosed to her/him/it, the parties may discuss whether to introduce into the contract an indemnification mechanism or additional obligations for the seller to remedy the known defect before or after the transaction is completed.

The content of the list of reps & warranties is brough forward in light of the buyer's business requirements and negotiated to match the level of warranty the seller is willing to grant. This list must always be seen by the seller in the context of the contractual provisions as a whole, in particular by reference to the definitions assigned to the concepts of "disclosed", "buyer's knowledge", "seller's knowledge". The final version of the clauses on reps & warranties must however lead to contractual balance, since only such a context is likely to create the premises for voluntary performance of obligations.

[1] Robert F. Bruner, Applied Mergers and acquisitions (Wiley 2004), p. 641. [2] Ibid, p. 769.

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