Buyers and Sellers: What to Watch Out For in Your Next M&A Transaction

Whether you’re the buyer, the seller, or the just the money behind it all, chances are that the “Representations and Warranties” section of a purchase agreement has sent you reaching for the ibuprofen. While Ice Cube may not have been thinking about corporate deals when he wrote “Check Yo Self,” there is wisdom in the advice. Skimping on your review and negotiation of the reps and warranties might save you attorney’s fees now, but it might wreck your business or your finances in the long run. A general understanding of the assurances made by each party will go a long way towards helping you navigate the legal jungle that is Transactional Law.

The Basics

The Lingo

M&A – Mergers and Acquisitions
R&W – Representations (or reps) and Warranties

Representations and Warranties

At their most basic, representations are statements of fact and warranties are promises. The statements of fact will relate to the past and present state of the business and the parties to the transaction. The parties then promise to each other these statements of fact are true, and will continue to be true, for a certain period of time, and to pay up if the ship, which you promised had no holes, sinks.

What do I rep to?

Depending on whose counsel drafts the initial purchase agreement and the scope of the agreement, the reps and warranties can vary drastically. A simple transaction without a large price tag might not exceed the standard fundamental reps outlined below, but if your transaction has more at stake or is committing people/places/things for a longer time period, adequately protecting your business interests is probably going to kill some trees.

Standard Reps

Standard “fundamental” reps and warranties assure each party the contract is valid and typically include:

1. Each party is a valid entity in good standing with the relevant governmental authority.
2. The representatives from each party have the authority necessary to enter into the contract.
3. The party funding the transaction has adequate funding.
4. There aren’t any conflicts that might invalidate the transaction.
5. There are no brokers due commissions on the transaction unless disclosed.

Kitchen Sink Reps

Once the fundamentals are out of the way, you can get into the issues specific to your business and the scope of the transaction. Intellectual property issues, privacy policy compliance, employee benefit plans, tax burdens and filings, compliance with laws and government regulations, major contracts, and more will get flushed out here. Try not to get bogged down in the shalls and shall nots, and go back to the good old days of sentence diagramming. Who is doing what to whom? Be mindful of comma placement; that silly, dangly bit of punctuation can dramatically change the meaning of a sentence.

Qualifiers

What do you know?

Knowledge qualifiers are fiercely negotiated because the definition of knowledge is not always straightforward. Generally, sellers are going to want their representations to be limited by what they actually know; buyers will want the seller’s representations to be based on what they “should have” known.

For example: Tony is selling his software company. Last year, a hacker infiltrated the server, but Tony doesn’t know it happened. Tony will want “actual knowledge” as the qualifier to the privacy compliance representation; he did not actually know. Sally, the buyer, will want to remove the knowledge qualifier entirely or replace it with “known, or should have known” because she can argue Tony should have known about the breach.

Material Adverse Effect

Materiality qualifiers will also effectively limit your exposure to liability by requiring that breaches to the representations have a substantial negative impact on the value of the purchased asset/interest before they are actionable.

In our example above, let’s assume Sally threw out Tony’s “actual knowledge” qualifier, but it turns out the hacker was only playing a practical joke and added smiley-faces to all the file names. Tony would be protected by a materiality qualifier in this case, because while there was a breach and he probably should have known about it, it did not have a substantial negative impact on the value of the company.

Disclosure Schedules

Again with the tree-killing, but I promise, it’s important. Your disclosure schedules will allow you, no matter which side of the transaction you are on, to outline exceptions to the representations and warranties to limit your liability. The rule of thumb here? When in doubt, disclose it. Your landlord mentioned in a phone call they might want to sell the building next year? Disclose it. Joanie got handsy at the Christmas party? Disclose it. You forgot to submit the progress report required by your license agreement? Disclose it. You get the picture.

Survival

In an effort to keep my musical references to one genre, I will not mention “I Will Survive” by Gloria Gaynor here. Oops. The survival period, or length of time your assurance needs to remain true in order to avoid breach of the agreement, will greatly impact the extent of your liability. Fundamental representations typically have a much longer survival period than non-fundamental ones. Most non-fundamental reps will remain in effect for 12-24 months after the closing date, whereas fundamental reps may extend 5-10 years or more beyond the closing date. In some cases, the statute of limitations for a particular element will govern, particularly in the case of environmental law reps.

On-Trend in M&A

Materiality Scrape

No, I’m not talking about a dental procedure. The materiality scrape is becoming more and more common in M&A transactions and is typically buried in the Indemnification section. With just a few sentences in legalese, it can effectively negate all the materiality qualifiers you and your attorney so lovingly added to the R&Ws.

#MeToo Reps

The #metoo movement has begun to impact M&A transactions of all sizes. If you are a buyer, you will want the sellers to disclose not just sexual harassment-related lawsuits, but HR-related complaints as well, as those can turn into lawsuits down the road. Proof the company has a sound sexual harassment policy in place and that it is followed by the company is key. If the seller or their employees will be staying on with the company as part of the transaction, sellers will want #metoo reps from the buyer, as well.

More about M&A

Hungry for more info about the ins and outs of M&A transactions? Check out our M&A Series.

Disclaimer: If “Check Yo Self” by Ice Cube is now stuck in your head and you feel the need to give it a listen, please remember it is by most accounts NSFW (Not Safe For Work) and headphones might be a good choice.